In, the answer would be in. But we would not say "he exaggerates his words," we would simply say: "He exaggerates in every conversation." You could also say: "John exaggerates at every opportunity." OR "John exaggerates on every occasion."

The correct preposition is "in." However, I would be remiss if I didn't add that the sentence itself is stilted, in large part because of its redundancy. If you are talking about a conversation, it is not necessary to point out that it is his words that are exaggerated. You would only give additional information like this if you are discussing activity that does not directly pertain to the conversation. For example, "Whenever I have a conversation with him, he always uses exaggerated gestures, sometimes even jumping up and down and waving his arms." I would write your sentence in this way: "Every time I speak with John, I notice that he has a tendency to exaggerate." (Very polite way of saying this.)