Visible ANSI escape sequences when running Emacs shell (these are not ANSI colors)
As you say, Emacs' eshell can't process escape codes -- it is a "dumb" terminal. But, your TERM variable setting is telling your shell that it IS capable of processing those escape codes.
Setting TERM to "dumb" when you're inside eshell should make those ugly escape codes go away.
Actually, emacs supports colors in shell, but only partially. There's a terminal description in ncurses (dumb-emacs-ansi), with notes on why you wouldn't want to use it (the comments preceding the entry).