Kodu is a set of visually oriented game creation tools that Microsoft will be releasing as a downloadable "game" for the Xbox 360 this Spring. The tools are icon-based and designed to be accessible, such that children would be able to create their own little games by setting up the rules of the world.
In fact, the team building Kodu are attempting to build it to be "accessible for children and enjoyable for anyone." Creating games will involve selecting objects, assigning behavior, building scoring mechanisms using simple equations, and so on. At the keynote, Microsoft had a 12-year-old girl named Sparrow quickly throw together something where a machine spit out objects while two robots tried to get them for points.
From the release:
“Kodu” created playgrounds are expressed in physical action-reaction terms, using basic concepts like vision, hearing and time to control your character’s behavior. Players can start their own unique “Kodu” created playgrounds from scratch or, if they aren’t in the mood to create, they can choose from several pre-loaded levels for quick play. With almost 200 different game-creation building blocks to choose from, the opportunities are endless.
So it sounds like they're trying to make something that can be used quickly for very simple concepts, but also building a system with enough depth to allow for a great deal of variety. Rather than coming out of one of the Microsoft Game Studios internal teams or a third-party, Kodu is being developed by Microsoft Research, which has been testing out stuff along these lines since at least 2006.
Kodu will launch in the Spring and will somehow be positioned alongside the XNA-based Community Games Channel, which strikes me as a little strange.