Probably unrelated, but as some point the coloring stopped working from the msys2 command line for me. I deleted msys2 and re-installed and it worked. This was on windows 7.
Those look like valid ANSI escape sequences, and a quick web search implies that VS Code does not understand them inherently.
You may want to try this extension. I haven’t tried it personally, but it has four stars, so it may be worth trying.
It’s also worth noting that on the platforms I’m familiar with – Linux and MAC – the operation of the terminal is controlled by the TERM environment variable, which usually defaults to xterm. There may be something equivalent in windows, making things work better with a different setting.