diff --git a/packages/coding-agent/examples/sdk/10-settings.ts b/packages/coding-agent/examples/sdk/10-settings.ts
index c42fab24..e91d7e2d 100644
--- a/packages/coding-agent/examples/sdk/10-settings.ts
+++ b/packages/coding-agent/examples/sdk/10-settings.ts
@@ -1,33 +1,38 @@
 /**
  * Settings Configuration
  *
- * Override settings from agentDir/settings.json.
+ * Override settings using SettingsManager.
  */
 
-import { createAgentSession, loadSettings, SessionManager } from "../../src/index.js";
+import { createAgentSession, loadSettings, SessionManager, SettingsManager } from "../../src/index.js";
 
-// Load current settings
+// Load current settings (merged global + project)
 const settings = loadSettings();
 console.log("Current settings:", JSON.stringify(settings, null, 2));
 
 // Override specific settings
+const settingsManager = SettingsManager.create();
+settingsManager.applyOverrides({
+	compaction: { enabled: false },
+	retry: { enabled: true, maxRetries: 5, baseDelayMs: 1000 },
+});
+
 const { session } = await createAgentSession({
-	settings: {
-		// Disable auto-compaction
-		compaction: { enabled: false },
-
-		// Custom retry behavior
-		retry: {
-			enabled: true,
-			maxRetries: 5,
-			baseDelayMs: 1000,
-		},
-
-		// Terminal options
-		terminal: { showImages: true },
-		hideThinkingBlock: true,
-	},
+	settingsManager,
 	sessionManager: SessionManager.inMemory(),
 });
 
 console.log("Session created with custom settings");
+
+// For testing without file I/O:
+const inMemorySettings = SettingsManager.inMemory({
+	compaction: { enabled: false },
+	retry: { enabled: false },
+});
+
+const { session: testSession } = await createAgentSession({
+	settingsManager: inMemorySettings,
+	sessionManager: SessionManager.inMemory(),
+});
+
+console.log("Test session created with in-memory settings");
diff --git a/packages/coding-agent/examples/sdk/12-full-control.ts b/packages/coding-agent/examples/sdk/12-full-control.ts
index f2efba49..4487828b 100644
--- a/packages/coding-agent/examples/sdk/12-full-control.ts
+++ b/packages/coding-agent/examples/sdk/12-full-control.ts
@@ -12,6 +12,7 @@ import {
 	defaultGetApiKey,
 	findModel,
 	SessionManager,
+	SettingsManager,
 	readTool,
 	bashTool,
 	type HookFactory,
@@ -53,6 +54,12 @@ const statusTool: CustomAgentTool = {
 const { model } = findModel("anthropic", "claude-sonnet-4-20250514");
 if (!model) throw new Error("Model not found");
 
+// In-memory settings with overrides
+const settingsManager = SettingsManager.inMemory({
+	compaction: { enabled: false },
+	retry: { enabled: true, maxRetries: 2 },
+});
+
 const { session } = await createAgentSession({
 	cwd: process.cwd(),
 	agentDir: "/tmp/my-agent",
@@ -71,7 +78,7 @@ Available: read, bash, status. Be concise.`,
 	contextFiles: [],
 	slashCommands: [],
 	sessionManager: SessionManager.inMemory(),
-	settings: { compaction: { enabled: false } },
+	settingsManager,
 });
 
 session.subscribe((event) => {
diff --git a/packages/coding-agent/src/core/sdk.ts b/packages/coding-agent/src/core/sdk.ts
index 0ecf4f24..60e09794 100644
--- a/packages/coding-agent/src/core/sdk.ts
+++ b/packages/coding-agent/src/core/sdk.ts
@@ -111,8 +111,8 @@ export interface CreateAgentSessionOptions {
 	/** Session manager. Default: SessionManager.create(cwd) */
 	sessionManager?: SessionManager;
 
-	/** Settings overrides (merged with agentDir/settings.json) */
-	settings?: Partial<Settings>;
+	/** Settings manager. Default: SettingsManager.create(cwd, agentDir) */
+	settingsManager?: SettingsManager;
 }
 
 /** Result from createAgentSession */
@@ -338,10 +338,10 @@ export function buildSystemPrompt(options: BuildSystemPromptOptions = {}): strin
 // Settings
 
 /**
- * Load settings from agentDir/settings.json.
+ * Load settings from agentDir/settings.json merged with cwd/.pi/settings.json.
  */
-export function loadSettings(agentDir?: string): Settings {
-	const manager = new SettingsManager(agentDir ?? getDefaultAgentDir());
+export function loadSettings(cwd?: string, agentDir?: string): Settings {
+	const manager = SettingsManager.create(cwd ?? process.cwd(), agentDir ?? getDefaultAgentDir());
 	return {
 		defaultProvider: manager.getDefaultProvider(),
 		defaultModel: manager.getDefaultModel(),
@@ -449,8 +449,8 @@ export async function createAgentSession(options: CreateAgentSessionOptions = {}
 	// Configure OAuth storage for this agentDir
 	configureOAuthStorage(agentDir);
 
-	const settingsManager = new SettingsManager(agentDir);
-	const sessionManager = options.sessionManager ?? SessionManager.create(cwd);
+	const settingsManager = options.settingsManager ?? SettingsManager.create(cwd, agentDir);
+	const sessionManager = options.sessionManager ?? SessionManager.create(cwd, agentDir);
 
 	// Check if session has existing data to restore
 	const existingSession = sessionManager.loadSession();
diff --git a/packages/coding-agent/src/core/settings-manager.ts b/packages/coding-agent/src/core/settings-manager.ts
index de4d0d06..e56b2779 100644
--- a/packages/coding-agent/src/core/settings-manager.ts
+++ b/packages/coding-agent/src/core/settings-manager.ts
@@ -1,6 +1,6 @@
 import { existsSync, mkdirSync, readFileSync, writeFileSync } from "fs";
 import { dirname, join } from "path";
-import { getAgentDir } from "../config.js";
+import { CONFIG_DIR_NAME, getAgentDir } from "../config.js";
 
 export interface CompactionSettings {
 	enabled?: boolean; // default: true
@@ -49,39 +49,118 @@ export interface Settings {
 	terminal?: TerminalSettings;
 }
 
-export class SettingsManager {
-	private settingsPath: string;
-	private settings: Settings;
+/** Deep merge settings: project/overrides take precedence, nested objects merge recursively */
+function deepMergeSettings(base: Settings, overrides: Settings): Settings {
+	const result: Settings = { ...base };
 
-	constructor(baseDir?: string) {
-		const dir = baseDir || getAgentDir();
-		this.settingsPath = join(dir, "settings.json");
-		this.settings = this.load();
+	for (const key of Object.keys(overrides) as (keyof Settings)[]) {
+		const overrideValue = overrides[key];
+		const baseValue = base[key];
+
+		if (overrideValue === undefined) {
+			continue;
+		}
+
+		// For nested objects, merge recursively
+		if (
+			typeof overrideValue === "object" &&
+			overrideValue !== null &&
+			!Array.isArray(overrideValue) &&
+			typeof baseValue === "object" &&
+			baseValue !== null &&
+			!Array.isArray(baseValue)
+		) {
+			(result as Record<string, unknown>)[key] = { ...baseValue, ...overrideValue };
+		} else {
+			// For primitives and arrays, override value wins
+			(result as Record<string, unknown>)[key] = overrideValue;
+		}
 	}
 
-	private load(): Settings {
-		if (!existsSync(this.settingsPath)) {
+	return result;
+}
+
+export class SettingsManager {
+	private settingsPath: string | null;
+	private projectSettingsPath: string | null;
+	private globalSettings: Settings;
+	private settings: Settings;
+	private persist: boolean;
+
+	private constructor(
+		settingsPath: string | null,
+		projectSettingsPath: string | null,
+		initialSettings: Settings,
+		persist: boolean,
+	) {
+		this.settingsPath = settingsPath;
+		this.projectSettingsPath = projectSettingsPath;
+		this.persist = persist;
+		this.globalSettings = initialSettings;
+		const projectSettings = this.loadProjectSettings();
+		this.settings = deepMergeSettings(this.globalSettings, projectSettings);
+	}
+
+	/** Create a SettingsManager that loads from files */
+	static create(cwd: string = process.cwd(), agentDir: string = getAgentDir()): SettingsManager {
+		const settingsPath = join(agentDir, "settings.json");
+		const projectSettingsPath = join(cwd, CONFIG_DIR_NAME, "settings.json");
+		const globalSettings = SettingsManager.loadFromFile(settingsPath);
+		return new SettingsManager(settingsPath, projectSettingsPath, globalSettings, true);
+	}
+
+	/** Create an in-memory SettingsManager (no file I/O) */
+	static inMemory(settings: Partial<Settings> = {}): SettingsManager {
+		return new SettingsManager(null, null, settings, false);
+	}
+
+	private static loadFromFile(path: string): Settings {
+		if (!existsSync(path)) {
+			return {};
+		}
+		try {
+			const content = readFileSync(path, "utf-8");
+			return JSON.parse(content);
+		} catch (error) {
+			console.error(`Warning: Could not read settings file ${path}: ${error}`);
+			return {};
+		}
+	}
+
+	private loadProjectSettings(): Settings {
+		if (!this.projectSettingsPath || !existsSync(this.projectSettingsPath)) {
 			return {};
 		}
 
 		try {
-			const content = readFileSync(this.settingsPath, "utf-8");
+			const content = readFileSync(this.projectSettingsPath, "utf-8");
 			return JSON.parse(content);
 		} catch (error) {
-			console.error(`Warning: Could not read settings file: ${error}`);
+			console.error(`Warning: Could not read project settings file: ${error}`);
 			return {};
 		}
 	}
 
+	/** Apply additional overrides on top of current settings */
+	applyOverrides(overrides: Partial<Settings>): void {
+		this.settings = deepMergeSettings(this.settings, overrides);
+	}
+
 	private save(): void {
+		if (!this.persist || !this.settingsPath) return;
+
 		try {
-			// Ensure directory exists
 			const dir = dirname(this.settingsPath);
 			if (!existsSync(dir)) {
 				mkdirSync(dir, { recursive: true });
 			}
 
-			writeFileSync(this.settingsPath, JSON.stringify(this.settings, null, 2), "utf-8");
+			// Save only global settings (project settings are read-only)
+			writeFileSync(this.settingsPath, JSON.stringify(this.globalSettings, null, 2), "utf-8");
+
+			// Re-merge project settings into active settings
+			const projectSettings = this.loadProjectSettings();
+			this.settings = deepMergeSettings(this.globalSettings, projectSettings);
 		} catch (error) {
 			console.error(`Warning: Could not save settings file: ${error}`);
 		}
@@ -92,7 +171,7 @@ export class SettingsManager {
 	}
 
 	setLastChangelogVersion(version: string): void {
-		this.settings.lastChangelogVersion = version;
+		this.globalSettings.lastChangelogVersion = version;
 		this.save();
 	}
 
@@ -105,18 +184,18 @@ export class SettingsManager {
 	}
 
 	setDefaultProvider(provider: string): void {
-		this.settings.defaultProvider = provider;
+		this.globalSettings.defaultProvider = provider;
 		this.save();
 	}
 
 	setDefaultModel(modelId: string): void {
-		this.settings.defaultModel = modelId;
+		this.globalSettings.defaultModel = modelId;
 		this.save();
 	}
 
 	setDefaultModelAndProvider(provider: string, modelId: string): void {
-		this.settings.defaultProvider = provider;
-		this.settings.defaultModel = modelId;
+		this.globalSettings.defaultProvider = provider;
+		this.globalSettings.defaultModel = modelId;
 		this.save();
 	}
 
@@ -125,7 +204,7 @@ export class SettingsManager {
 	}
 
 	setQueueMode(mode: "all" | "one-at-a-time"): void {
-		this.settings.queueMode = mode;
+		this.globalSettings.queueMode = mode;
 		this.save();
 	}
 
@@ -134,7 +213,7 @@ export class SettingsManager {
 	}
 
 	setTheme(theme: string): void {
-		this.settings.theme = theme;
+		this.globalSettings.theme = theme;
 		this.save();
 	}
 
@@ -143,7 +222,7 @@ export class SettingsManager {
 	}
 
 	setDefaultThinkingLevel(level: "off" | "minimal" | "low" | "medium" | "high" | "xhigh"): void {
-		this.settings.defaultThinkingLevel = level;
+		this.globalSettings.defaultThinkingLevel = level;
 		this.save();
 	}
 
@@ -152,10 +231,10 @@ export class SettingsManager {
 	}
 
 	setCompactionEnabled(enabled: boolean): void {
-		if (!this.settings.compaction) {
-			this.settings.compaction = {};
+		if (!this.globalSettings.compaction) {
+			this.globalSettings.compaction = {};
 		}
-		this.settings.compaction.enabled = enabled;
+		this.globalSettings.compaction.enabled = enabled;
 		this.save();
 	}
 
@@ -180,10 +259,10 @@ export class SettingsManager {
 	}
 
 	setRetryEnabled(enabled: boolean): void {
-		if (!this.settings.retry) {
-			this.settings.retry = {};
+		if (!this.globalSettings.retry) {
+			this.globalSettings.retry = {};
 		}
-		this.settings.retry.enabled = enabled;
+		this.globalSettings.retry.enabled = enabled;
 		this.save();
 	}
 
@@ -200,7 +279,7 @@ export class SettingsManager {
 	}
 
 	setHideThinkingBlock(hide: boolean): void {
-		this.settings.hideThinkingBlock = hide;
+		this.globalSettings.hideThinkingBlock = hide;
 		this.save();
 	}
 
@@ -209,7 +288,7 @@ export class SettingsManager {
 	}
 
 	setShellPath(path: string | undefined): void {
-		this.settings.shellPath = path;
+		this.globalSettings.shellPath = path;
 		this.save();
 	}
 
@@ -218,7 +297,7 @@ export class SettingsManager {
 	}
 
 	setCollapseChangelog(collapse: boolean): void {
-		this.settings.collapseChangelog = collapse;
+		this.globalSettings.collapseChangelog = collapse;
 		this.save();
 	}
 
@@ -227,7 +306,7 @@ export class SettingsManager {
 	}
 
 	setHookPaths(paths: string[]): void {
-		this.settings.hooks = paths;
+		this.globalSettings.hooks = paths;
 		this.save();
 	}
 
@@ -236,7 +315,7 @@ export class SettingsManager {
 	}
 
 	setHookTimeout(timeout: number): void {
-		this.settings.hookTimeout = timeout;
+		this.globalSettings.hookTimeout = timeout;
 		this.save();
 	}
 
@@ -245,7 +324,7 @@ export class SettingsManager {
 	}
 
 	setCustomToolPaths(paths: string[]): void {
-		this.settings.customTools = paths;
+		this.globalSettings.customTools = paths;
 		this.save();
 	}
 
@@ -254,10 +333,10 @@ export class SettingsManager {
 	}
 
 	setSkillsEnabled(enabled: boolean): void {
-		if (!this.settings.skills) {
-			this.settings.skills = {};
+		if (!this.globalSettings.skills) {
+			this.globalSettings.skills = {};
 		}
-		this.settings.skills.enabled = enabled;
+		this.globalSettings.skills.enabled = enabled;
 		this.save();
 	}
 
@@ -280,10 +359,10 @@ export class SettingsManager {
 	}
 
 	setShowImages(show: boolean): void {
-		if (!this.settings.terminal) {
-			this.settings.terminal = {};
+		if (!this.globalSettings.terminal) {
+			this.globalSettings.terminal = {};
 		}
-		this.settings.terminal.showImages = show;
+		this.globalSettings.terminal.showImages = show;
 		this.save();
 	}
 }
diff --git a/packages/coding-agent/src/main.ts b/packages/coding-agent/src/main.ts
index 5fa89a5a..1ad5616e 100644
--- a/packages/coding-agent/src/main.ts
+++ b/packages/coding-agent/src/main.ts
@@ -288,7 +288,7 @@ export async function main(args: string[]) {
 	const isInteractive = !parsed.print && parsed.mode === undefined;
 	const mode = parsed.mode || "text";
 
-	const settingsManager = new SettingsManager();
+	const settingsManager = SettingsManager.create(cwd);
 	initTheme(settingsManager.getTheme(), isInteractive);
 
 	let scopedModels: ScopedModel[] = [];
diff --git a/packages/coding-agent/src/utils/shell.ts b/packages/coding-agent/src/utils/shell.ts
index bde51928..d2a1f74f 100644
--- a/packages/coding-agent/src/utils/shell.ts
+++ b/packages/coding-agent/src/utils/shell.ts
@@ -34,7 +34,7 @@ export function getShellConfig(): { shell: string; args: string[] } {
 		return cachedShellConfig;
 	}
 
-	const settings = new SettingsManager();
+	const settings = SettingsManager.create();
 	const customShellPath = settings.getShellPath();
 
 	// 1. Check user-specified shell path
diff --git a/packages/coding-agent/test/agent-session-branching.test.ts b/packages/coding-agent/test/agent-session-branching.test.ts
index b29299f4..d14fa483 100644
--- a/packages/coding-agent/test/agent-session-branching.test.ts
+++ b/packages/coding-agent/test/agent-session-branching.test.ts
@@ -57,7 +57,7 @@ describe.skipIf(!API_KEY)("AgentSession branching", () => {
 		});
 
 		sessionManager = noSession ? SessionManager.inMemory() : SessionManager.create(tempDir);
-		const settingsManager = new SettingsManager(tempDir);
+		const settingsManager = SettingsManager.create(tempDir, tempDir);
 
 		session = new AgentSession({
 			agent,
diff --git a/packages/coding-agent/test/agent-session-compaction.test.ts b/packages/coding-agent/test/agent-session-compaction.test.ts
index a2574483..7a31053b 100644
--- a/packages/coding-agent/test/agent-session-compaction.test.ts
+++ b/packages/coding-agent/test/agent-session-compaction.test.ts
@@ -61,7 +61,7 @@ describe.skipIf(!API_KEY)("AgentSession compaction e2e", () => {
 		});
 
 		sessionManager = SessionManager.create(tempDir);
-		const settingsManager = new SettingsManager(tempDir);
+		const settingsManager = SettingsManager.create(tempDir, tempDir);
 
 		session = new AgentSession({
 			agent,
@@ -177,7 +177,7 @@ describe.skipIf(!API_KEY)("AgentSession compaction e2e", () => {
 		// Create in-memory session manager
 		const noSessionManager = SessionManager.inMemory();
 
-		const settingsManager = new SettingsManager(tempDir);
+		const settingsManager = SettingsManager.create(tempDir, tempDir);
 
 		const noSessionSession = new AgentSession({
 			agent,