Obama will also nominate Army General David Petraeus, the head of US and NATO forces in Afghanistan, to replace Panetta as CIA director, and veteran diplomat Ryan Crocker as US ambassador to Afghanistan, US officials said.
The long-anticipated changes, which must be confirmed by the Senate, would place a long-standing Democratic Party figure at the helm of the Pentagon as Barack Obama presses forward with politically delicate policies in Afghanistan and Libya.
The administration and Congress also face mounting calls for defence spending cuts as Washington looks for ways to narrow the yawning US budget deficit, which stands at $1.4 trillion this year.
The current defence chief, Robert Gates, was appointed by former president George W Bush, a Republican, and has proved to be an outspoken maverick on key issues under both administrations.
Gates, himself a former CIA director, had made it clear that he would step down as defence chief this year.
Leon Panetta, who turns 73 in June, is a former United States representative from California who served as chairman of the House Budget Committee. He was former president Bill Clinton's budget director, then chief of staff.
A US official said Obama would nominate Panetta later this week.
Petraeus, 58, is a popular figure credited with pulling Iraq from the brink of civil war after the 2003 United States invasion before he assumed command of United States iand NATO forces in Afghanistan. Before the word of the reshuffle broke, some Washington insiders suggested the White House wanted a high-profile position for Petraeus to ensure he would not be tapped by Republicans to challenge Obama next year.
Veteran diplomat RyanCrocker has served as United States ambassador to Iraq, Pakistan, Syria, Kuwait and Lebanon.