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The treatment of large bone defects requires bone tissue substitutes. However, the lack of accessible autologous bone, especially in newborns with spina bifida or cleft palate conditions, severely limits therapeutic options involving bone grafts. Here, an engineering approach to reconstruct bone is presented by combining human amniocentesis-derived amniotic fluid progenitor cells (hAFCs) and a biomimetic, injectable, and fully synthetic poly(ethylene glycol) hydrogel that is crosslinked enzymatically by transglutaminase FXIII (TG-PEG). hAFCs are isolated by their colony-forming capacity, expanded in vitro, and undergo osteogenic, chondrogenic, or adipogenic differentiation under appropriate stimulation. When encapsulated in TG-PEG hydrogels, hAFCs rapidly deposit endogenous extracellular matrix (ECM) in vitro. hAFC-laden TG-PEG hydrogels containing low concentrations of bone morphogenetic protein (BMP-2) promote formation of ectopic bone organoids in vivo in a murine model without requiring prior in vitro differentiation. Strikingly, hAFC-induced constructs form as much bone in this model as adult bone marrow-derived stromal cells (hBMSCs), and significantly more than adipose-derived stromal cells (hASCs). Utilization of autologous hAFCs embedded in TG-PEG hydrogels presents a promising therapeutic strategy for bone replacement, particularly in fetuses and newborns where limited stem cell availability can be overcome through minimally invasive harvest of amniotic fluid.