The zebrafish mutant kugelig (kgg) is caused by a defect in the caudal-related homeobox gene cdx4 and has a deficit in both ‘primitive' and ‘definitive' hematopoietic stem cells. The embryonic anemia in the mutants can be rescued by overexpressing hox genes such as hoxb7a and hoxa9a, but not hoxb8a. This suggests that specific hox genes are required to make mesoderm competent to form blood. To further explore this, we undertook a microarray analysis to identify differentially expressed genes in kgg mutants and wild-type embryos. We found that raldh2, an enzyme required for retinoic acid (RA) production, is overexpressed in kgg mutants during the early stages of blood formation. This data led us to hypothesize that RA may act to suppress blood formation and that the cdx-hox pathway functions to limit RA production, thereby permitting blood formation to occur. To test this, we treated wild-type zebrafish embryos with RA and found that they became severely anemic. Treating kgg embryos with DEAB, a chemical that blocks raldh2 activity, restored hematopoiesis in kgg mutants. Expression of hoxa9a was not rescued in these treated embryos, indicating that RA acts downstream of the hox genes. DEAB also induced an expansion of erythroid cells in wild-type embryos, thus supporting the notion that the levels of RA during development are a critical determinant for blood formation. By performing a time-course rescue experiment, we determined that DEAB is effective when scl + hematopoietic progenitors are first formed from mesoderm, suggesting that RA acts upstream of the blood-inducer scl. In support of this, SCL overexpression rescues GATA-1 expression in embryos treated with RA. We next looked at the effects of DEAB and RA on the formation of mouse hematopoietic progenitors arising from ES cell-derived embryoid bodies (EBs). Addition of DEAB to EBs between days 2 to 3 of development resulted in a 5–8 fold increase in ‘primitive' erythroid colonies (CFU-Ep), analogous to our results in zebrafish embryos. In contrast, RA treatment caused a general inhibition in the growth of all colony types. Taken together, these results suggest a new model in which suppression of RA by the cdx-hox pathway is necessary for yolk sac hematopoiesis to occur. This model provides an explanation for how hox genes control the spatiotemporal formation of hematopoietic tissue during organogenesis and may shed new light on the pathogenesis of leukemias involving translocations of the cdx , hox, and retinoic acid receptors.