This is basically a good approach.
If your embedded devices have a good IPv6 stack, I recommend using it instead of IPv4. link local addresses work better with IPv6. Most IPv4 stacks are configured to try to obtain an address from a DHCP server first, and only fall back to link local addresses if they can't get one. The link local address and DHCP address might be mutually exclusive, so the link local address doesn't become operational until after DHCP has been tried and timed out. The link local address might even be disrupted if DHCP periodically retries. Although the devices will normally be connected to each other and there won't be a DHCP server, you don't want to disable DHCP, because the devices probably should obtain a DHCP address if they are ever connected to a wider network. With IPv6 on the other hand, the link local addresses come up immediately when the interface comes up, and stay up continuously while other IP addresses (from autoconf or from DHCPv6) may come and go.
Link local addresses alone won't let the devices contact each other by hostname, but dns-sd (mDNS, zeroconf) will. If you are using Linux then you can use avahi as a dns-sd stack.
Better than using hostnames, consider having the devices probe for each other by dns-sd service type. If you are using a custom protocol between your devices, make up a unique service tpe name and have the devices advertise themselves it and probe for it with dns-sd.