You'll need to sand that all off to bare metal to get under that corrosion and bondo if there is any. The only real way to "stabilize" that (including cracks) is to get rid of it. Then go back with a good epoxy primer. You may have to do a little hammer and dolly work to get a nice fit between the fender and extension.
Epoxy primer first then body filler if needed but only a skim coat. I personally don't use filler if I can avoid it - new metal and work it to get a good fit makes the best paint jobs and no surprises later.
They don't need to be able to shift, they should be bolted tight to one another but they can work loose and move around. That being said they are different metals and can expand and contract at different rates but that should not cause the problem you are having. "popping the paint out" Is more than likely poor preparation, cheap primer, bondo coming loose, etc... If bodywork and metal prep are done right and with quality products then you won't have these issues.
Also a possibility (at least on the fender) is if you have pinholes in your fender then moisture could be getting under the paint from the inside of the fender. Make sure the fender is prepped/primered underside as well.
Thanks for the info guys, Ill be checking out how snug everything is. Kate's going to be a daily driver so I want to make sure she's safe as possible from rust.