Should aerobraking vessels using SAS aim towards orbital retrograde? Or Surface retrograde?

There is no wind in Kerbal Space Program (without mods, that is), so the atmosphere around any planet (or moon) is always rotating at the same rate as the surface.

Therefore, yes, if you wish to maintain a specific attitude (e.g. prograde or retrograde) with respect to the air surrounding you, you should indeed set your SAS to surface mode.

To get the most out of aerobraking you want to orient your craft in the direction that gives you the most drag without your ship blowing up (or losing any components you want to keep). That means the ideal orientation depends on the craft and the speed and angle of entry into the atmosphere. If you can survive any orientation then you want to orient your craft so it presents the most drag, that usually that means the with the largest possible area facing retrograde with the navball in surface mode. In most designs this means you'd want to tell SAS to face radial in/out or normal/anti-normal while manually rotating the craft to present the largest area in your direction of travel.

Alternatively if you're trying to minimize the amount effect of the atmosphere, either because you're going too fast to survive any other way, or your trying to escape the atmosphere then you usually want your smallest surface area facing prograde. That would mean using surface mode and telling SAS to face prograde.

Note that because of atmospheric effects you may not have much of a choice. The force of the atmosphere may turn your vessel into a particular direction unless you have sufficient attitude control to counteract it. Also note that forward facing parts shield the parts behind from the heat effects of aerobraking so the choice of facing may depend on what parts of your ship are the most heat tolerant. The design of your ship plays a significant role.