Electronic – External watchdog reset for AVR required

Looking at the datasheet:

14.3.4.5 Watchdog Reset The Watchdog Reset is entered when a watchdog fault occurs. This state lasts 3 Slow Clock cycles.

When in Watchdog Reset, assertion of the reset signals depends on the WDRPROC bit in WDT_MR: If WDRPROC is 0, the Processor Reset and the Peripheral Reset are asserted. The NRST line is also asserted, depending on the programming of the field ERSTL. However, the resulting low level on NRST does not result in a User Reset state.

Could it be that the watchdog is firing and driving the reset line?

Yeah, that is because after the watchdog fires, you have to reset the corresponding flag before main starts again (there is a register where you can read out, what caused the reset) and to disable the watchdog from firing over and over.

This code will fix your problem:

    // This function is called upon a HARDWARE RESET:
void reset(void) __attribute__((naked)) __attribute__((section(".init3")));

/*! Clear SREG_I on hardware reset. */
void reset(void)
{
     cli();
    // Note that for newer devices (any AVR that has the option to also
    // generate WDT interrupts), the watchdog timer remains active even
    // after a system reset (except a power-on condition), using the fastest
    // prescaler value (approximately 15 ms). It is therefore required
    // to turn off the watchdog early during program startup.
    MCUSR = 0; // clear reset flags
    wdt_disable();
}

This .init3 thing is a special code section where you can put code that is run before main starts. Here is a link that describes that, but you shouldn't worry too much about it, the code above will work just fine when put into the main.c.