According to what looks like legitimate Microsoft documentation, the Xbox 360 will soon support USB mass storage through an official System Update. There are a few caveats, however.
From the looks of it, the 360 will support pretty much any size of external hard drive (over 1GB), and this drive can be partitioned to be partially or fully dedicated to Xbox 360 files—including DLC, XBLA titles, games on demand and general game updates. Ooh, and even Avatar items!!! (Note: You can already play media like movies off of connected drives.)
The catch? Microsoft seems to have capped 360 partitions to a maximum of 16GB, no matter how large the drive you're using may be. 16GB isn't much, especially since even the original 360 launched with a measly 20GB drive. [Joystiq]