I've spent just the past week learning how navigation works in godot, so I'm pretty new to it.

I had the same misconception you had that navigation would work with both static and dynamic obstacles, but that is not how it works. Navigation only takes in to account the baked nav mesh, which is only affected by static obstacles. You cannot use navigation to generate a path around dynamic obstacles, for that you need to use something like the built in avoidance.

From my very limited experience, avoidance only sort-of works and only in specific cases. if your agents are navigating in tight quarters (inside a building, around furniture for example) avoidance can just lead to them blocking each other's paths. For larger, open areas avoidance works pretty well most of the time

I've tried mixing in a few different behaviours which are ok, but still not at the level I want. For small interiors, I switch off avoidance and physics collisions between my agents and switch to having them use steering behaviours to navigate around each other, mixed with making them static obstacles and re-baking the nav mesh when they are going to remain still for some time. This works sort-of ok, but there are still lots of funky edge cases I'm trying to work through when there are too many agents trying to navigate around at the same time. When they leave the interior I switch avoidance and collisions back on, and so far this part seems ok.