If President Barack Obama thought he could deliver the promise of a few Israeli concessions during his upcoming Cairo speech to the Muslim world, he was sorely mistaken.

Far more than his predecessor George W. Bush did, Obama has been leaning hard on Israel to halt its expansion of Jewish settlements in the Palestinian territories and to declare its readiness to accept a "two-state solution," meaning an Israeli and a Palestinian state living side by side. But the mood in Jerusalem is defensive. At a Sunday Cabinet meeting, Israeli ministers openly defied the U.S. demands. Israeli Transport Minister Yisrael Katz told Army Radio, "I want to make it clear that the current Israeli government will not accept in any way the freezing of legal settlement activity in Judea and Samaria [the biblical name for the West Bank]."

In response to Washington's pressure, the right-wing government of Prime Minister Benjamin Netanyahu had thought it might earn a little breathing space with the Obama Administration by destroying a few illegal settlers' outposts. But even that has gone badly. No sooner did the army bulldozers plow under a few hilltop outposts — usually nothing more than a few trailers and shacks built on private Palestinian land — than the settlers were back with renewed zeal, along with nails and concrete to rebuild their smashed homes. As one settler, Ariyeh Davis, told the Israeli Internet news agency Ynet, "Our answer is 'expansion against expulsion.' " He added, "God willing, we'll build new places, and from 300,000 residents in Judea and Samaria, we'll become 600,000." (See TIME's photo-essay "The Vatican and the Jews.")

Obama's Cairo speech is supposed to set a new course for U.S. policy in the turbulent Middle East; the key to its success is to promote the image that his Administration is taking a more evenhanded approach to the Arab-Israeli conflict than did his predecessor. But this has not gone down well with Netanyahu's hawkish Cabinet, which is grumbling in the Israeli press that Obama has gone too far the other way, supposedly granting concessions to Palestinians that are "unfair" to Israelis. The Israeli press made much of the fact that Obama's meeting with Palestinian Authority President Mahmoud Abbas in Washington last week seemed much more cordial than Obama's strained encounter earlier with Netanyahu. A cartoon in the Hebrew daily Yedioth Ahronoth showed Obama and Abbas laughing chummily while throwing darts at Netanyahu's portrait.

At the core of the dispute between the two allies is Washington's insistence that Israel honor its past accords and halt all construction within the West Bank settlements, whose expansion is seen as an obstacle to peace. The Palestinians say the settlements, with their road networks and military-security cordons, are chopping and dicing the territory into so many pieces that its own state could never be viable.

The Israelis want Washington to permit the "natural growth" of the settlements — i.e., allow the children of existing settlers to build new homes — which U.S. Secretary of State Hillary Clinton says she opposes. The Israelis also argue that while sacrifices are being asked of them, little is being demanded of the Palestinians. Abbas, who, according to aides, came away from Washington convinced of "Obama's seriousness" in pushing Israel to remove settlements, says he refuses to hold peace talks with Netanyahu until the Israeli Premier publicly backs the two-state solution, something he has been loathe to do.

Meantime, the Palestinian leader is trying rather blatantly to show Washington that while he may have lost Gaza to the Islamic militants Hamas, his security forces are still capable of policing the West Bank. On Sunday, Abbas' forces raided a Hamas stronghold in the West Bank town of Qalqilya; six were killed in the resulting clash. This may be a way for Abbas to prove to Obama that he's fulfilling his security promises, but the shoot-out could wreck ongoing talks in Egypt between Abbas and Hamas over forming a unity government that would bring the West Bank and Gaza under a single Palestinian leadership. As a Hamas official in Gaza told TIME, "All this proves is that Abbas is carrying out the bidding of our enemy Israel."

For now, all Abbas has to do is sit quietly while Netanyahu takes the heat from Washington — and from his own fractious coalition partners. The Cabinet right wingers want Netanyahu to stand firm against Obama's demands to halt the settlements, while Labor, in the words of Knesset member Ophir Pines, wants Netanyahu to face his "moment of truth." Says Pines: "The government needs to decide whether it prefers good relations with the American Administration or whether it prefers the illegal settlement in the territories. All of the talk about natural growth in the settlements is a bluff, and the Americans know that." Obama may just call Netanyahu's bluff, which would undoubtedly complicate the friendship between the U.S. and its closest Middle East partner. But the chances of reviving peace talks between the Israelis and Arabs will be the better for it.