Stress induces aversive memory overgeneralization, a hallmark of many psychiatric disorders. Memories for events are encoded by a sparse ensemble of principal neurons active during an event, termed an engram ensemble. Using engram labeling tools, molecular sensors, optogenetics and CRISPR-Cas9 gene editing in specific neuronal populations we examined the molecular and circuit processes mediating stress-induced threat memory overgeneralization in mice. We found that stress, acting via corticosterone, increases the density of engram ensembles supporting a threat memory and this less sparse engram ensemble is reactivated by both specific and non-specific retrieval cues (generalized threat memory). Furthermore, we identify a functional role for endocannabinoids, acting retrogradely on parvalbumin-positive (PV+) interneurons, in the formation of a larger, less sparse engram and memory generalization induced by stress. Glucocorticoid receptor antagonists, endocannabinoid synthesis inhibitors, increasing the activity of PV+ neurons and knocking down cannabinoid receptors specifically in PV+ neurons were all sufficient to restore threat memory specificity and a sparse engram in mice with high CORT levels. These findings offer insights into stress-induced memory alterations, providing potential therapeutic avenues for stress-related disorders.