Forget the settlements for a moment, would you have a problem with a Jewish American who decides to live in Israel full stop? The answer surely must be no? However, if Israel did not exist then this would be impossible so a Jewish state must exist and indeed also coexist.
This is the right to self-determination, the creation of Israel and ability to settle there fulfils that right for Jewish people of any creed. Denying this right outright is the aim of the anti-zionist movement and is regarded as anti-semitic (at least in western recognised definitions).
The illegal settlements are a matter of criticism towards the Israeli government and its policy for implementing how people come to fulfil their right. It should indeed not deny the rights of the Palestinian people, if it does then the fault of that lies with the Israeli government and not the people exercising their rights or the simple fact that the right exists.
As I said previously, there's a reason why Israel contains people of many different creeds and backgrounds, it's because a Jewish state did not exist until the last 100 years and now it does. Jewish people had otherwise chosen to settle in many places such as the US because they were safe there. Obviously many Jewish people have now chosen to settle in Israel however many choose to stay in countries as is their right as citizens of those countries. This is what self-determination is.
In terms of what we can recognise and what is morally right the Palestinians should have a right to coexist within a separate state alongside Israel however this has never been agreed. A Palestinian state cannot supersede the existence of Israel nor vice versa... And here lies the problem....
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