Why can't I install Windows on my USB drive?
A collection of limitations (both hardware and software) currently prevent Windows from booting and running off a USB drive. Some of them are described in this whitepaper from WinHEC 2003. Another reason not mentioned in this paper is that during any hot-plug operation, the USB bus is completely reinitialized. Windows really doesn’t like it when it loses access to its boot device. Imagine, you plug in a USB camera, the USB bus reinitializes, Windows loses access to the boot drive, and oops the kernel needs to page in some data and it can’t. Rats.
But who knows, someday maybe it will work.