At PAX East today, Microsoft confirmed that support for USB devices is on the way for the Xbox 360. On April 6, a 360 system update will be released allowing you to use a USB device with your 360. Flash devices are supported, and USB hard drives "may" work with the 360, but both will be limited to a 16GB partition, so let's not get crazy or anything. Flash drives are "highly recommended" over USB hard drives. You'll be able to have two USB devices on your system at a time, boosting memory to an added 32 GB.
While any Flash drive will work with the 360, Microsoft is partnering with Sandisk to release a pre-configured 360-branded USB drive, for Xbox loyalists. That comes out in May. The system update will also provide some enhanced memory functions to make moving data between your storage devices a little smoother.
This is a step in the right direction, especially for 360 users like me who bought a tiny hard drive model, but I can't help but be a little concerned/angered by the 16 GB limit on the USB drives. I'm no technical genius, but couldn't the "ceiling" just as easily been 32 GB? But whatever; I just can't wait to free up precious hard-drive space by making a Rock Band USB device!
Source: Major Nelson