I assume that you see the same behavior with other X applications, i.e. it's
not xterm-specific?
No, at least xedit works fine on my PC, with blind keys and with mouse text pasting,
no matter if the mouse pointer is really inside or on blue window frame or
(for blind keys:) really outside.
Actually, maybe this is an xterm problem?
It seems to be somehow related to the xterm's --enable-toolbar configuration
(which is turned on in the cygwin package). If I rebuild xterm with that
disabled, the problem goes away, and I can also reproduce the problem on F15
under twm if I build xterm with --enable-toolbar there (which is not enabled
in the distro supplied package)