I think the title works on several levels. The background is the political context (I do not take this film to be heavily political) where Israel was "dancing" with Bashir - Lebanon christian prime-minister.
The more important context or sub-context is the soldier dance with the machine gun under heavy fire which is an allegory to the craziness of the war, and war.
Also, and I hope I can convey this idea in words: the movie score is not one of a war film but has an opera like feeling e.g. the piano melody during an action scene. It's a dream-like experience, perhaps the story of a difficult time but yet the youth of the storyteller who tells us a story of a long-almost-forgotten Waltz like, surreal like period of his life. It connects well the absurdity/craziness of war.
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