Bone marrow mesenchymal stromal/stem cell (MSC) encapsulation within a biomatrix could improve cellular delivery and extend survival and residence time over conventional intravenous administration. Although MSCs modulate monocyte/macrophage (Mø) immunophenotypic properties, little is known about how such interactions are influenced when MSCs are entrapped within a biomaterial. Furthermore, the impact of the cell-encapsulating matrix on MSC multipotency and on Møs, which infiltrate biomaterials, remains poorly understood. Here we elucidate this three-way interaction. The Mø immunophenotype and MSC differentiation were examined with regard to established and experimental collagen-based biomaterials for MSC entrapment. Tumor necrosis factor-α secretion was acutely inhibited at 4 days. MSCs cocultured with Møs demonstrated attenuated chondrocyte differentiation, whereas osteoblast differentiation was enhanced. Adipocyte differentiation was considerably enhanced for MSCs entrapped within the gelatin/polyethylene glycol-based matrix. A better understanding of the effect of cell encapsulation on differentiation potency and immunomodulation of MSCs is essential for MSC-based, biomaterial-enabled therapies.