I think, reading all these suggestions to return them straight away, you should talk to your friend.
I could see one of my friends asking for them back, but I know she wouldn't be hung up on specifics. If a handful of the items got stained, or ripped, or otherwise worn out, no biggie, chuck it, and if items got mixed up, so be it. She would just mean "pay 'em forward to keep the chain moving, I'd like the next recipient to be" more then "these exact clothes". Sure she'd expect some of the items to make it through your kid to the next, but she wouldn't be hung up on details, or expect all of them would.
So talk to your friend and see if she means "all of them" or if she just means "pay them forward". If she means "pay them forward" you can reasonably expect to get some back yourself, once her SIL's kid outgrows them and you are onto #2. If she really means all of them, or if you aren't comfortable with her SIL being in your chain, then I agree its too much hassle and you should just be done with them before even starting.