Chronic antigen stimulation is thought to generate dysfunctional CD8 T cells. Here, we identify a CD8 T cell subset in the bone marrow tumor microenvironment that, despite an apparent terminally exhausted phenotype (TPHEX), expressed granzymes, perforin, and IFN-γ. Concurrent gene expression and DNA accessibility revealed that genes encoding these functional proteins correlated with BATF expression and motif accessibility. IFN-γ+ TPHEX effectively killed myeloma with comparable efficacy to transitory effectors, and disease progression correlated with numerical deficits in IFN-γ+ TPHEX. We also observed IFN-γ+ TPHEX within CD19-targeted chimeric antigen receptor T cells, which killed CD19+ leukemia cells. An IFN-γ+ TPHEX gene signature was recapitulated in TEX cells from human cancers, including myeloma and lymphoma. Here, we characterize a TEX subset in hematological malignancies that paradoxically retains function and is distinct from dysfunctional TEX found in chronic viral infections. Thus, IFN-γ+ TPHEX represent a potential target for immunotherapy of blood cancers.