DOS (including FreeDOS) tends not to behave too well on systems without any floppy drives: it may reserve drive letters A: and B: regardless, and return errors when they are actually accessed. And even though your computer has no floppy drive, the BIOS firmware may still report one as being present, for example in order to support installing a floppy drive in a hot-swappable extension bay like in some Dell laptops.
Most importantly though, when a second floppy drive is not present, DOS enables its second drive emulation feature. It simply makes the single floppy drive available under both A: and B: drive letters, and prompts the user to swap floppies when the program attempts to access files on the ‘other’ drive. Though I cannot explain what made installer access the B: drive, this feature is what triggers the message displayed in your screenshot.
As for solutions, I can offer one: disable both floppy drive letters before running the installer.
Ensure you have the DEBUG program ready on your USB stick (any version; Microsoft’s, as you may extract from Windows 98 CAB files, FreeDOS’s or ecm’s). Next to the DEBUG executable, save the following text file as NOFDD.TXT:
; disable drive A:
mov ax, 5f08
mov dl, 0
; disable drive B:
mov ax, 5f08
mov dl, 1
mov ax, 4c00
Remember to set CR+LF line endings. The blank lines are important, but you can skip lines starting with a semicolon. At the DOS command prompt, launch
DEBUG < NOFDD.TXT; this will create a small program named NOFDD.COM which disables floppy drive letters A: and B: and makes them unavailable until the next reboot. (If you skip the first section, it will disable the B: drive only.) You can invoke it directly by starting
NOFDD the command line, or put in in AUTOEXEC.BAT or in an
INSTALL= directive in CONFIG.SYS.
NOFDD (you can check that switching to drive A: or B: no longer works and returns messages like ‘Invalid drive A:’), launch the installer as before; one should hope the above will get you through this particular hurdle, or at least give you a more informative error message.
All that said… it’s probably not too wise to install Windows 9x directly from USB media.
First of all, the installation process involves a number of reboots from the target medium. Since Windows 98 has no built-in drivers for USB drives, this means you may lose access to the installation files on the USB drive after the reboot, unless you take additional steps, like copying CAB files onto the target partition, or even installing DOS USB drivers (FreeDOS does come with those).
Another potential problem is that drive letters may shift between reboots: when booting from a USB flash drive, BIOS firmware often presents it as hard drive number 0 (0x80) while actual internal hard drives are numbered starting from 1 (0x81), but when booting from an internal hard drive, those are numbered starting from 0, while USB drives are hidden. This may disrupt DOS’s drive letter assignment algorithm and invalidate any pathnames the installer may have written in the target system’s configuration.
For these reasons, it is probably better to copy installation files onto the target partition and always boot from the latter; compare this question.