T cell-specific transcription factor (TCF-1) and lymphoid enhancer factor 1 (LEF-1) have been implicated exclusively in the regulation of T cell-specific genes. The only adult tissue other than thymus known to express these factors is spleen and lymph node, which contain low levels of LEF-1 and no TCF-1. We noticed that genes involved in hair-specific gene expression possess LEF-1/TCF-1 consensus motifs located in similar positions relative to their TATA box. We show that of the two factors only LEF-1 is expressed in hair follicles; it can be cloned in both splice forms from human skin keratinocytes and it can bind to these sites in the hair promoters. We show that LEF-1 mRNA is present in pluripotent ectoderm, and it is up-regulated in a highly restricted pattern just before the formation of underlying mesenchymal condensates and commitment of overlying ectodermal cells to invaginate and become hair follicles. New waves of ectodermal LEF-1 spots appear concomitant with new waves of follicle morphogenesis. To test whether LEF-1 patterning might be functionally important for hair patterning and morphogenesis, we used transgenic technology to alter the patterning and timing of LEF-1 over the surface ectoderm. Striking abnormalities arose in the positioning and orientation of hair follicles, leaving a marked disruption of this normally uniform patterning. This provides the first direct evidence that ectodermal cues are critical in establishing these developmental processes, which at later stages are known to be influenced by underlying mesenchyme. Remarkably, elevated LEF-1 in the lip furrow epithelium of developing transgenic animals triggered these cells to invaginate, sometimes leading to the inappropriate adoption of hair follicle and tooth cell fates. Collectively, our findings demonstrate that ectodermal expression of LEF-1 plays a central role in gene expression, pattern formation, and other developmental processes involving epithelial-mesenchymal associations.