PD-1 is a T cell inhibitor for which blocking agents have achieved success as anti-cancer therapeutics. The current view is that cancer limits host immune responses by upregulating PD-L1 in the tumor microenvironment thereby causing PD-1 ligation and inactivation of CD8+ Teff cells. Recently, we determined that PD-1 alters the differentiation of myeloid progenitors during cancer-mediated emergency myelopoiesis. We found that PD-1 is expressed in granulocyte/macrophage progenitors (GMP), which accumulate during cancer-driven emergency myelopoiesis and give rise to myeloid-derived suppressor cells (MDSC) that promote tumor growth. In tumor-bearing mice with myeloid-specific PD-1 ablation, accumulation of GMP and MDSC was prevented, while output of effector myeloid cells was increased. PD-1-mediated T cell inactivation is attributed to the function of SHP-2 phosphatase, which is activated by recruitment to PD-1 cytoplasmic tail. Temporal activation of SHP-2 is critical for myeloid cell fate. Activating SHP-2 mutations prevent myeloid cell differentiation and lead to the accumulation of immature myelocytes and development of leukemia. To determine whether PD-1-mediated inhibition of anti-tumor immunity relies on SHP-2-mediated effects in T cells or myeloid cells, we generated mice with conditional targeting of the Ptpn11 gene (encoding for Shp-2) and selectively eliminated Shp-2 in T cells (Shp-2fl/flLckCre) or myeloid cells (Shp-2fl/flLysMCre). No significant difference in tumor growth was observed between control Shp2fl/fl and Shp-2fl/flLckCre mice bearing B16-F10 melanoma. Strikingly, Shp-2fl/flLysMCre mice had significantly diminished tumor growth that was not further decreased by anti-PD-1 antibody, in contrast to control Shp-2fl/fl mice in which anti-PD-1 treatment significantly reduced tumor size. To determine how Shp-2 ablation affected the properties of myeloid cells, we examined CD11b+Ly6ChiLy6G- monocytic (M-MDSC), CD11b+Ly6CloLy6G+ polymorphonuclear (PMN-MDSC), CD11b+F4/80+ tumor-associated macrophages (TAM) and CD11c+MHCII+ dendritic cells (DC). No quantitative differences were observed in these myeloid subsets in tumor bearing mice among the different groups. However, M-MDSC from Shp-2fl/flLysMCre mice had elevated expression of CD86 and IFNγ, consistent with effector differentiation. Suppression assays, by measuring antigen-specific responses of OTI transgenic T cells, showed significantly attenuated suppressor function of MDSC isolated from tumor-bearing Shp-2f/fLysMCre mice compared to control or Shp-2f/fLckCre mice. CD38 is a key mediator of MDSC-mediated immunosuppression. It is an ADP-ribosyl cyclase that has ectoenzyme and receptor functions, is induced early during differentiation of myeloid progenitors by retinoic acid receptor alpha (RARα) signaling, and mediates T cell immunosuppression. Because Shp-2 is involved in the differentiation of myeloid progenitors, we examined CD38 expression. We found that expression of CD38 was significantly reduced in MDSC from Shp-2fl/flLysMCre mice compared to control and Shp-2fl/flLckCre-tumor bearing mice. Since the suppressive potency of MDSC is decreased by autophagy, and SHP-2 has been implicated in regulating autophagy in cancer cells, we examined autophagy of MDSC in our system. Assessment of autophagy in ex vivo isolated MDSC, using Cyto-ID that stains the autophagosome membrane and indicates autophagic activity, showed enhanced autophagy in MDSC isolated from tumor bearing Shp-2fl/flLysMCre mice compared to control or Shp-2fl/flLckCre mice. Enhanced autophagy was also detected in bone marrow-derived MDSC from Shp-2fl/flLysMCre mice as determined by accumulation of LC3B-II and p62 during culture under conditions of starvation-induced stress. Consistent with the diminished MDSC suppressor function, myeloid cell-specific Shp-2 ablation in tumor-bearing mice induced an increase of CD8+ T cells showing an effector phenotype with improved functionality, despite preserved expression of PD-1 and Shp-2. Together these results indicate that inhibition of PD-1-mediated SHP-2 activation in myeloid progenitors, thereby preventing the accumulation of immature immunosuppressive MDSC and promoting the differentiation of effector myeloid cells, might be a previously unidentified mechanism by which PD-1 blockade mediates anti-tumor function. Disclosures No relevant conflicts of interest to declare.