Mesenchymal stromal cells (MSCs) have shown promise as a treatment for osteoarthritis (OA); however, effective translation has been limited by numerous factors ranging from high variability and heterogeneity of hMSCs, to suboptimal delivery strategies, to poor understanding of critical quality and potency attributes. The objective of the current study was to assess the effects of biomaterial encapsulation in alginate microcapsules on human MSC (hMSC) secretion of immunomodulatory cytokines in an OA microenvironment and therapeutic efficacy in treating established OA. Lewis rats underwent Medial Meniscal Transection (MMT) surgery to induce OA. Three weeks post-surgery, after OA was established, rats received intra-articular injections of either encapsulated hMSCs or controls (saline, empty capsules, or non-encapsulated hMSCs). Six weeks post-surgery, microstructural changes in the knee joint were quantified using contrast enhanced microCT. Encapsulated hMSCs attenuated progression of OA including articular cartilage degeneration (swelling and cartilage loss) and subchondral bone remodeling (thickening and hardening). A multiplexed immunoassay panel (41 cytokines) was used to profile the in vitro secretome of encapsulated and non-encapsulated hMSCs in response to IL-1□, a key cytokine involved in OA. Non-encapsulated hMSCs showed an indiscriminate increase in all cytokines in response to IL-1□ while encapsulated hMSCs showed a highly targeted secretory response with increased expression of some pro-inflammatory (IL-1β, IL-6, IL-7, IL-8), anti-inflammatory (IL-1RA), and chemotactic (G-CSF, MDC, IP10) cytokines. These data show that biomaterial encapsulation using alginate microcapsules can modulate hMSC paracrine signaling in response to OA cytokines and enhance the therapeutic efficacy of the hMSCs in treating established OA.