diff --git a/.dagger/modules/e2e/dagger.json b/.dagger/modules/e2e/dagger.json
index 0466464..a8bdbc1 100644
--- a/.dagger/modules/e2e/dagger.json
+++ b/.dagger/modules/e2e/dagger.json
@@ -1,6 +1,6 @@
 {
   "name": "e2e",
-  "engineVersion": "v0.21.4",
+  "engineVersion": "v1.0.0-0",
   "sdk": {
     "source": "dang"
   },
diff --git a/.dagger/modules/e2e/fixtures/mixed-discovery/.dagger-python-sdk-skip-generate b/.dagger/modules/e2e/fixtures/mixed-discovery/.dagger-python-sdk-skip-generate
new file mode 100644
index 0000000..8b13789
--- /dev/null
+++ b/.dagger/modules/e2e/fixtures/mixed-discovery/.dagger-python-sdk-skip-generate
@@ -0,0 +1 @@
+
diff --git a/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/dagger-module.toml b/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/dagger-module.toml
new file mode 100644
index 0000000..036bad5
--- /dev/null
+++ b/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/dagger-module.toml
@@ -0,0 +1,4 @@
+engineVersion = "v1.0.0-0"
+
+[runtime]
+source = "python"
diff --git a/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/dagger.json b/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/dagger.json
new file mode 100644
index 0000000..02e020a
--- /dev/null
+++ b/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/dagger.json
@@ -0,0 +1,7 @@
+{
+  "name": "mixed-discovery-app",
+  "engineVersion": "v1.0.0-0",
+  "sdk": {
+    "source": "python"
+  }
+}
diff --git a/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/nested/deeper/.keep b/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/nested/deeper/.keep
new file mode 100644
index 0000000..8b13789
--- /dev/null
+++ b/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/nested/deeper/.keep
@@ -0,0 +1 @@
+
diff --git a/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/pyproject.toml b/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/pyproject.toml
new file mode 100644
index 0000000..cb28635
--- /dev/null
+++ b/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/pyproject.toml
@@ -0,0 +1,12 @@
+[project]
+name = "mixed-discovery-app"
+version = "0.1.0"
+requires-python = ">=3.14"
+dependencies = ["dagger-io"]
+
+[build-system]
+requires = ["uv_build>=0.8.4,<0.9.0"]
+build-backend = "uv_build"
+
+[tool.uv.sources]
+dagger-io = { path = "sdk", editable = true }
diff --git a/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/src/mixed_discovery_app/__init__.py b/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/src/mixed_discovery_app/__init__.py
new file mode 100644
index 0000000..e8b0dc4
--- /dev/null
+++ b/.dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app/src/mixed_discovery_app/__init__.py
@@ -0,0 +1,6 @@
+from dagger import object_type
+
+
+@object_type
+class MixedDiscoveryApp:
+    pass
diff --git a/.dagger/modules/e2e/fixtures/toml/.dagger-python-sdk-skip-generate b/.dagger/modules/e2e/fixtures/toml/.dagger-python-sdk-skip-generate
new file mode 100644
index 0000000..8b13789
--- /dev/null
+++ b/.dagger/modules/e2e/fixtures/toml/.dagger-python-sdk-skip-generate
@@ -0,0 +1 @@
+
diff --git a/.dagger/modules/e2e/fixtures/toml/app/dagger-module.toml b/.dagger/modules/e2e/fixtures/toml/app/dagger-module.toml
new file mode 100644
index 0000000..036bad5
--- /dev/null
+++ b/.dagger/modules/e2e/fixtures/toml/app/dagger-module.toml
@@ -0,0 +1,4 @@
+engineVersion = "v1.0.0-0"
+
+[runtime]
+source = "python"
diff --git a/.dagger/modules/e2e/fixtures/toml/app/nested/.keep b/.dagger/modules/e2e/fixtures/toml/app/nested/.keep
new file mode 100644
index 0000000..8b13789
--- /dev/null
+++ b/.dagger/modules/e2e/fixtures/toml/app/nested/.keep
@@ -0,0 +1 @@
+
diff --git a/.dagger/modules/e2e/main.dang b/.dagger/modules/e2e/main.dang
index a39ae7b..a1932eb 100644
--- a/.dagger/modules/e2e/main.dang
+++ b/.dagger/modules/e2e/main.dang
@@ -13,6 +13,9 @@ type E2e {
   let depsModulePath: String! = fixtureRoot + "/deps/app"
   let configModulePath: String! = fixtureRoot + "/config/app"
   let configuredModulePath: String! = fixtureRoot + "/config/configured"
+  let tomlModulePath: String! = fixtureRoot + "/toml/app"
+  let mixedDiscoveryModulePath: String! = fixtureRoot + "/mixed-discovery/ancestor/work/app"
+  let mixedDiscoveryNestedPath: String! = mixedDiscoveryModulePath + "/nested/deeper"
 
   let generatedMarkerPath: String! = "sdk/src/dagger/client/gen.py"
   let generatedMarkerContents: String! = "Code generated by dagger."
@@ -73,12 +76,47 @@ type E2e {
     let nested = pythonSdk.mod(ws, path: lookupNestedPath)
     let exact = pythonSdk.mod(ws, path: lookupModulePath, findUp: false)
 
-    assert(nested.path == lookupModulePath, "find-up lookup returned the wrong module path")
-    assert(exact.path == lookupModulePath, "exact lookup returned the wrong module path")
+    assert(nested.rootPath == lookupModulePath, "find-up lookup returned the wrong module path")
+    assert(exact.rootPath == lookupModulePath, "exact lookup returned the wrong module path")
 
     null
   }
 
+  """
+  Lookup must choose the nearest module config even when its filename differs
+  from an ancestor config, and modern TOML modules must be supported.
+  """
+  pub mixedConfigLookupCheck(ws: Workspace!): Void @check {
+    let mod = pythonSdk.mod(ws, path: tomlModulePath + "/nested")
+    assert(mod.rootPath == tomlModulePath, "lookup chose an outer dagger.json instead of the nearer dagger-module.toml")
+    null
+  }
+
+  """
+  Managed-module discovery is cwd-aware and supports both config formats.
+  """
+  pub moduleDiscoveryCheck(ws: Workspace!): Void @check {
+    let roots = pythonSdk.modules(ws).{{rootPath}}.map { mod => mod.rootPath }
+    assert(contains(roots, generateModulePath), "root discovery missed a legacy Python module")
+    assert(contains(roots, tomlModulePath), "root discovery missed a TOML Python module")
+    assert(contains(roots, nonPythonModulePath) == false, "discovery included a non-Python module")
+
+    let nestedWs = ws.directory("/").asWorkspace(cwd: lookupNestedPath)
+    let scoped = pythonSdk.modules(nestedWs).{{rootPath, path}}
+    let scopedRoots = scoped.map { mod => mod.rootPath }
+    let scopedPaths = scoped.map { mod => mod.path }
+    assert(scoped.length == 1, "nested cwd should see only its nearest managed module")
+    assert(contains(scopedRoots, lookupModulePath), "nested cwd resolved the wrong managed module")
+    assert(contains(scopedPaths, ".."), "module path should be relative to the nested cwd")
+
+    let mixedWs = ws.directory("/").asWorkspace(cwd: mixedDiscoveryNestedPath)
+    let mixed = pythonSdk.modules(mixedWs).{{rootPath, path}}
+    assert(mixed.length == 1, "mixed-config cwd should see only its nearest managed module")
+    assert(contains(mixed.map { mod => mod.rootPath }, mixedDiscoveryModulePath), "mixed-config discovery chose the farther dagger-module.toml")
+    assert(contains(mixed.map { mod => mod.path }, "../.."), "mixed-config module path should be relative to the nested cwd")
+    null
+  }
+
   """
   initModule should seed SDK-owned template files without running codegen and
   without writing engine-owned files (dagger.json / dagger-module.toml).
@@ -153,18 +191,6 @@ type E2e {
     null
   }
 
-  """
-  initClient should not materialize files itself. The engine records the client
-  and owns the generated context changeset.
-  """
-  pub initClientCheck(ws: Workspace!): Void @check {
-    let changes = pythonSdk.initClient(ws, path: outputRoot + "/client", module: generateModulePath, dev: true)
-
-    assert(changes.isEmpty, "initClient should return an empty SDK changeset")
-
-    null
-  }
-
   """
   config.get should reflect pyproject.toml and report unset values as null
   rather than guessing, and config.set should edit only pyproject.toml.
diff --git a/dagger.json b/dagger.json
index 62c29c8..f92c506 100644
--- a/dagger.json
+++ b/dagger.json
@@ -7,8 +7,8 @@
   "dependencies": [
     {
       "name": "polyfill",
-      "source": "github.com/dagger/sdk-sdk/polyfill@main",
-      "pin": "a16466390cacd68bd72f7ae9910d990966fb2226"
+      "source": "github.com/dagger/polyfill@main",
+      "pin": "e90bbfc4843258a877a3a95b8db1571e7981e65f"
     }
   ]
 }
diff --git a/dagger.toml b/dagger.toml
index 724adf6..47265a4 100644
--- a/dagger.toml
+++ b/dagger.toml
@@ -27,3 +27,9 @@ path = ".dagger/modules/e2e/fixtures/deps/app"
 
 [[modules.python-sdk.as-sdk.modules]]
 path = ".dagger/modules/e2e/fixtures/skip/app"
+
+[[modules.python-sdk.as-sdk.modules]]
+path = ".dagger/modules/e2e/fixtures/toml/app"
+
+[[modules.python-sdk.as-sdk.modules]]
+path = ".dagger/modules/e2e/fixtures/mixed-discovery/ancestor/work/app"
diff --git a/docs/cwd-aware-discovery.md b/docs/cwd-aware-discovery.md
new file mode 100644
index 0000000..e342183
--- /dev/null
+++ b/docs/cwd-aware-discovery.md
@@ -0,0 +1,20 @@
+# CWD-aware module discovery
+
+The Python SDK delegates config discovery to `github.com/dagger/polyfill`, then
+intersects the discovered directories with `currentModule.asSDK.modules`. The
+engine's managed-module list remains authoritative while the caller's current
+directory determines scope.
+
+Discovery returns modules at or below the cwd and, when the cwd has no module
+config, its nearest enclosing module. Both `dagger-module.toml` and legacy
+`dagger.json` are considered together, so the nearest config wins regardless of
+filename. Virtual environments and installed packages are excluded.
+
+```console
+dagger check -l
+dagger call e-2-e mixed-config-lookup-check
+dagger call e-2-e module-discovery-check
+```
+
+The fixtures cover mixed nested config formats, modern and legacy configs,
+non-Python exclusion, root discovery, and discovery from inside a module.
diff --git a/mod.dang b/mod.dang
index 6d64737..9ff4f4b 100644
--- a/mod.dang
+++ b/mod.dang
@@ -3,9 +3,9 @@ A Dagger module that uses the Python SDK.
 """
 type Mod {
   """
-  Workspace-relative path of this module root.
+  Workspace-root-relative path of this module root.
   """
-  pub path: String!
+  pub rootPath: String!
 
   """
   The workspace this module belongs to.
@@ -17,18 +17,37 @@ type Mod {
   """
   let skipGenerateFilename: String!
 
+  """
+  Module root relative to the client's cwd.
+  """
+  pub path: String! {
+    let cwd = ws.cwd.trimPrefix("/").trimSuffix("/")
+    if (rootPath == cwd) {
+      "."
+    } else if (cwd == "") {
+      rootPath
+    } else if (rootPath.trimPrefix(cwd + "/") != rootPath) {
+      rootPath.trimPrefix(cwd + "/")
+    } else if (rootPath == "." or cwd.trimPrefix(rootPath + "/") != cwd) {
+      let depth = if (rootPath == ".") { 0 } else { rootPath.split("/").length }
+      cwd.split("/").dropFirst(depth).map { segment => ".." }.join("/")
+    } else {
+      rootPath
+    }
+  }
+
   """
   Whether this module or an ancestor contains the configured generate skip marker.
   """
   pub skipGenerate: Boolean! {
-    ws.findUp(name: skipGenerateFilename, from: path) != null
+    ws.findUp(name: skipGenerateFilename, from: rootPath) != null
   }
 
   """
   Manage this module's Python build configuration (pyproject.toml).
   """
   pub config: ModConfig! {
-    ModConfig(path: path, ws: ws)
+    ModConfig(path: rootPath, ws: ws)
   }
 
   """
@@ -39,7 +58,7 @@ type Mod {
     if (skipGenerate) {
       polyfill.workspace(ws).fork.changes
     } else {
-      polyfill.workspace(ws).moduleSource("/" + path).generate.changes
+      polyfill.workspace(ws).moduleSource("/" + rootPath).generate.changes
     }
   }
 }
diff --git a/python-sdk.dang b/python-sdk.dang
index 730f61e..6f0ca99 100644
--- a/python-sdk.dang
+++ b/python-sdk.dang
@@ -2,6 +2,10 @@
 Manage Dagger modules that use the Python SDK.
 """
 type PythonSdk {
+  let legacyConfigPattern = "\"sdk\"\\s*:\\s*\\{[^}]*\"source\"\\s*:\\s*\"python\""
+  let tomlConfigPattern = "\\[runtime\\][^\\[]*source\\s*=\\s*\"python\""
+  let moduleConfigFilenames: [String!]! = ["dagger-module.toml", "dagger.json"]
+
   """
   Marker filename that skips generate when found at or above a Python SDK module root.
   """
@@ -13,29 +17,47 @@ type PythonSdk {
   pub targetRuntime: String! { "python" }
 
   """
-  Return every legacy dagger.json Dagger module whose sdk.source is "python".
-
-  This discovery path is obsolete for workspace-managed modules; the engine
-  owns the modules.<sdk>.as-sdk.modules source of truth.
+  Return every managed Python SDK module visible from the client's cwd: the
+  nearest enclosing module plus modules at or below the cwd. Discovery uses the
+  shared polyfill and intersects its results with the SDK list on the passed
+  workspace.
   """
   pub modules(ws: Workspace!): [Mod!]! {
-    ws
-      .directory("/", include: ["**/dagger.json"])
-      .search(
-        pattern: "\"sdk\"\\s*:\\s*\\{[^}]*\"source\"\\s*:\\s*\"python\"",
-        globs: ["**/dagger.json"],
-        filesOnly: true,
-        multiline: true,
-        dotall: true,
-      )
-      .{{filePath}}
-      .map { configPath =>
-        mod(
-          ws,
-          if (configPath.filePath == "dagger.json") { "." } else { configPath.filePath.trimSuffix("/dagger.json") },
-          findUp: false,
-        )
+    let managed = ws.sdk(name: currentModule.name).modules.{{source}}
+    let cwd = normalizePath(ws.cwd)
+    polyfill.workspace(ws)
+      .findConfigDirs(moduleConfigFilenames, exclude: ["**/.venv/**", "**/site-packages/**"])
+      .map { dir => workspacePath(cwd, dir) }
+      .uniq
+      .filter { path => managed.filter { m => normalizePath(m.source) == path }.length > 0 }
+      .map { path => Mod(rootPath: path, ws: ws, skipGenerateFilename: skipGenerateFilename) }
+  }
+
+  let workspacePath(cwd: String!, path: String!): String! {
+    let base = if (cwd == ".") { [] } else { cwd.split("/") }
+    let segments = path.split("/").reduce(base) { acc, segment =>
+      if (segment == "..") {
+        acc.dropLast(1)
+      } else if (segment == "." or segment == "") {
+        acc
+      } else {
+        acc + [segment]
       }
+    }
+    if (segments.length == 0) { "." } else { segments.join("/") }
+  }
+
+  let normalizePath(path: String!): String! {
+    let normalized = path.trimPrefix("./").trimPrefix("/").trimSuffix("/")
+    if (normalized == "") { "." } else { normalized }
+  }
+
+  let pathDepth(path: String): Int! {
+    if (path == null) { -1 } else if (path == ".") { 0 } else { path.split("/").length }
+  }
+
+  let configDir(path: String!, filename: String!): String! {
+    normalizePath(path.trimPrefix("/").trimSuffix(filename))
   }
 
   """
@@ -71,42 +93,42 @@ type PythonSdk {
   """
   pub mod(ws: Workspace!, path: String! = ".", findUp: Boolean! = true): Mod! {
     let modPath = if (findUp) {
-      let foundConfigPath = ws.findUp("dagger.json", path)
-      if (foundConfigPath == null) {
+      let foundToml = ws.findUp("dagger-module.toml", path)
+      let foundJson = ws.findUp("dagger.json", path)
+      let tomlBase = if (foundToml == null) { null } else { configDir(foundToml, "dagger-module.toml") }
+      let jsonBase = if (foundJson == null) { null } else { configDir(foundJson, "dagger.json") }
+
+      if (tomlBase == null and jsonBase == null) {
         raise "no Dagger module found containing path: " + path
+      } else if (tomlBase != null and pathDepth(tomlBase) > pathDepth(jsonBase)) {
+        validateConfig(ws, tomlBase, "dagger-module.toml", tomlConfigPattern, path)
+      } else if (jsonBase != null) {
+        validateConfig(ws, jsonBase, "dagger.json", legacyConfigPattern, path)
       } else {
-        let configPath = foundConfigPath.trimPrefix("/")
-        if (
-          ws
-            .directory("/", include: [configPath])
-            .file(configPath)
-            .search(
-              pattern: "\"sdk\"\\s*:\\s*\\{[^}]*\"source\"\\s*:\\s*\"python\"",
-              multiline: true,
-              dotall: true,
-              limit: 1,
-            )
-            .{{id}}
-            .length == 0
-        ) {
-          raise "Dagger module does not use the Python SDK: " + path
-        } else if (configPath == "dagger.json") {
-          "."
-        } else {
-          configPath.trimSuffix("/dagger.json")
-        }
+        raise "no Dagger module found containing path: " + path
       }
     } else {
-      path.trimPrefix("/")
+      normalizePath(path)
     }
 
     Mod(
-      path: modPath,
+      rootPath: modPath,
       ws: ws,
       skipGenerateFilename: skipGenerateFilename,
     )
   }
 
+  let validateConfig(ws: Workspace!, base: String!, filename: String!, pattern: String!, requestedPath: String!): String! {
+    let configPath = if (base == ".") { filename } else { base + "/" + filename }
+    let matches = ws
+      .directory("/", include: [configPath])
+      .file(configPath)
+      .search(pattern: pattern, multiline: true, dotall: true, limit: 1)
+      .{{id}}
+      .length > 0
+    if (matches) { base } else { raise "Dagger module does not use the Python SDK: " + requestedPath }
+  }
+
   """
   Initialize Python-owned files for a new Dagger module.
 
@@ -191,22 +213,17 @@ type PythonSdk {
   }
 
   """
-  Generate all discovered legacy dagger.json Python SDK modules.
-
-  This discovery path is obsolete for workspace-managed modules; the engine
-  owns the modules.<sdk>.as-sdk.modules source of truth.
+  Generate every managed Python SDK module visible from the client's cwd.
 
   Modules with the generate skip marker are skipped.
   """
   pub generateAll(ws: Workspace!): Changeset! @generate {
     let pws = polyfill.workspace(ws)
 
-    currentModule.asSDK.modules
-      .{{path}}
-      .map { m => Mod(path: m.path, ws: ws, skipGenerateFilename: skipGenerateFilename) }
+    modules(ws)
       .filter { mod => mod.skipGenerate == false }
       .reduce(pws.fork) { fork, mod =>
-        fork.merge(pws.moduleSource("/" + mod.path).generate)
+        fork.merge(pws.moduleSource("/" + mod.rootPath).generate)
       }
       .changes
   }