The major concern of pancreatic islet transplantation is that the implanted islets are exposed to the immune system of the recipient. To overcome this challenge, the peptide amphiphile (PA) nanomatrix gel was used for immunoisolation of islets through microencapsulation. The PA can self-assemble to form a nanomatrix gel with an extracellular matrix-mimicking, islet nurturing microenvironment and a semipermeable immune barrier. In this study, the islet protective effect of the PA nanomatrix gel was evaluated by coculture of PA-encapsulated human islets with differentiated U937 cells (human monocyte cell-line) for 3 and 7 days. The coculture of the bare islets with the differentiated U937 cells stimulated proinflammatory cytokine (IL-1β and TNF-α) secretion and caused islet death after 7 days, which simulated an early inflammatory response environment after islet transplantation. The PA-encapsulated islets, however, did not stimulate proinflammatory cytokine secretion and maintained islet viability up to 7 days. More insulin-producing β cells were observed in PA-encapsulated islets compared to bare islet controls after exposure to differentiated U937 cells for 7 days compared to the bare islets. This result was confirmed by dithizone staining analysis. Further evaluation of islet functionality was assessed by a glucose-stimulated insulin secretion test. The PA-encapsulated islets showed greater insulin secretion response to glucose stimulation than the bare islets with the differentiated U937 cells after 3 and 7 days. These results demonstrated that islet encapsulation with the PA nanomatrix gel was able to improve islet survival and function in the presence of inflammatory responses, which will increase the success rate of islet engraftment and the efficacy of islet transplantation.