It is critical to understand how stem cell activity is regulated during regeneration. Hair follicles constitute an important model for organ regeneration because, throughout adult life, they undergo cyclical regeneration. Hair follicle stem cells—epithelial cells located in the follicle bulge—are activated by periodic β-catenin activity, which is regulated not only by epithelial-derived Wnt, but also, through as-yet-undefined mechanisms, the surrounding dermal microenvironment. The matricellular protein connective tissue growth factor (CCN2) is secreted into the microenvironment and acts as a multifunctional signaling modifier. In adult skin, CCN2 is largely absent but is unexpectedly restricted to the dermal papillae and outer root sheath. Deletion of CCN2 in dermal papillae and the outer root sheath results in a shortened telogen-phase length and elevated number of hair follicles. Recombinant CCN2 causes decreased β-catenin stability in keratinocytes. In vivo, loss of CCN2 results in elevated numbers of K15-positive epidermal stem cells that possess elevated β-catenin levels and β-catenin–dependent reporter gene expression. These results indicate that CCN2 expression by dermal papillae cells is a physiologically relevant suppressor of hair follicle formation by destabilization of β-catenin and suggest that CCN2 normally acts to maintain stem cell quiescence.