Microcluster formation is a hallmark of PD1 engagement, but its physical basis and functional impact have remained unclear. We show that ligand-bound PD1 triggers Shp2 self-association and liquid liquid phase separation, generating dynamic condensates whose liquidity depends on Shp2 catalytic activity. Mutations that disrupt Shp2 self-association weaken PD1 microclusters and reduce inhibitory signaling. These findings identify Shp2 phase separation as a fundamental organizing mechanism of the PD1 pathway, linking enzymatic activation, substrate selectivity, and higher-order assembly to suppress T cell responses. This work reveals a biophysical mechanism of PD1-mediated immune regulation with implications for improving checkpoint blockade therapies.