I heard somewhere that Dago was a slightly derogatory term used between the northern and southern Italians, but can't remember which direction it went.

It seems to me the words aren't that bad as is, but if you feel uncomfortable singing them there are perhaps more acceptable two syllable words to substitute -- "Irish fiddler's tune" - "gypsy fiddler's tune" "Irish Mike" "gypsy dave" etc.

Another ethical problem comes with changing a modern songwriter's words -- of course, one could argue, that's the folk process.