The answer is libvirt NSS. This is Fedora 26:
yum install libvirt-nss
And enable the NSS module with two “libvirt” keywords:
# egrep ^host /etc/nsswitch.conf hosts: files libvirt libvirt_guest dns myhostname
DNS resolution just works for all my libvirt guests now. NSS will figure it out according to dnsmasq DHCP records (hostname entry). If that’s not advertised by a guest, then it will use VM name. For FQDN you need to rename your VM names to include domain too, e.g. vm1.home.lan.
For more visit documentation.
Hurray! No more fiddling with /etc/hosts, no more dnsmasq split setups or hacks via virsh. This is elegant solution.
Via Kamil Páral’s blog.