The US is cutting more than $200m (£155m) in aid to the Palestinians, the State Department said.
Funds, originally planned for programmes in the West Bank and Gaza, would address "high-priority projects elsewhere", a senior State Department official said without elaborating what they would be used for.
"We have undertaken a review of US assistance to the Palestinian Authority and in the West Bank and Gaza to ensure these funds are spent in accordance with U.S. national interests and provide value to the US taxpayer," they said in a statement. "As a result of that review, at the direction of the president, we will redirect more than $200 million in FY2017 Economic Support Funds originally planned for programmes in the West Bank and Gaza."
Asked where the money would be redirected and whether it would go to other Palestinian projects, another State Department official said: "We will work with Congress to redirect these funds to other policy priorities."
Both officials spoke on condition of anonymity.
The announcement came at a time when the Palestinian leadership has angered the White House by boycotting its peace efforts since President Donald Trump recognised Jerusalem as Israel's capital and moved the embassy there, reversing decades of US policy.
The status of Jerusalem - home to sites holy to the Muslim, Jewish and Christian religions - is one of the biggest obstacles to any peace agreement between Israel and the Palestinians.
Palestinians claim East Jerusalem for the capital of an independent state they seek. Israel says Jerusalem is its eternal and indivisible capital.
Mr Trump's son-in-law and senior adviser Jared Kushner is leading an effort to craft a peace plan meant to launch negotiations between Israel and the Palestinians to end a decades-long conflict. A decision on when the initiative would be rolled out has not yet been made.
The State Department cited the Islamist militant group Hamas' control of Gaza as part of its justification for reallocating the funds. The United States and Israel designate Hamas as a terrorist group.
Palestine Liberation Organisation (PLO) Executive Committee member Hanan Ashrawi accused the Trump administration of using "cheap blackmail as a political tool."
"The Palestinian people and leadership will not be intimidated and will not succumb to coercion," she said.
Ambassador Husam Zomlot, head of the PLO General Delegation to the United States, said in a statement: "Weaponising humanitarian and developmental aid as political blackmail does not work."
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