The Netanyahu government in Israel has approved the building of 455 new homes for settlers in the West Bank - in defiance of Mr Obama's call for a complete settlement freeze.
One former US diplomat with extensive experience of the Middle East calls it "a huge slap in the face" for the Obama administration.
Israeli Prime Minister Benjamin Netanyahu is trying to have it both ways.
He wants to appease the settler lobby by allowing new construction, and to appease the Americans by finalising an agreement on a temporary freeze.
But he is in danger of satisfying no-one.
The White House has been quick to condemn the new announcement.
A Palestinian spokesman, Saeb Erakat, said the Israeli decision "nullifies any effect that a settlement freeze, when and if announced, will have".
Even the settlers and their supporters are unimpressed.
One Israeli analyst - quoted by the French news agency AFP - called the announcement "a sedative given to the settler lobby before proceeding with the painful operation of freezing settlements".
Good intentions
On the Middle East, as on other issues, Barack Obama entered the White House full of good intentions.
The Bush administration had neglected the peace process. He would revive it.
Mr Bush had shunned Iran and Syria. Mr Obama would talk to them.
But like other presidents before him, he has discovered how resistant the region's problems are to solution.
Mr Obama, and his tireless Middle East special envoy George Mitchell, are still struggling to achieve some sort of breakthrough before 23 September.
That's when the president is expected to address the new session of the UN General Assembly.
He would like to use the occasion for a three-way meeting in New York with Mr Netanyahu and Palestinian Authority President Mahmoud Abbas.
This would set the seal on the re-launch of Israeli-Palestinian peace talks.
Question of credibility
But, with little more than two weeks to go, the pieces of the puzzle are stubbornly refusing to fall into place.
Mr Mitchell is due to return to Israel in a few days, for one more shot at finalising a settlement freeze.
But even if there is deal, this will not be the "complete" freeze Mr Obama has been calling for. The signs are that it would be temporary - for six to nine months - and would exclude Jerusalem.
Would that entice the Arabs into the game?
Mr Abbas says that without a meaningful freeze he won't resume talks.
The Arab states would be reluctant to take even modest steps towards normalising relations with Israel, as the Americans are urging them to.
Failure in the Middle East would damage Mr Obama's credibility.
As he grapples with the domestically difficult issue of healthcare and with an unpopular war in Afghanistan, many would conclude that he had bitten off more than he can chew.
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