Baucus, 72, who has served Montana in the Senate since 1978, has long been a key figure in building the Sino-US trading relationship and is known for holding Beijing to account to international economic and commercial regulations.
"For more than two decades, Max Baucus has worked to deepen the relationship between the United States and China," Obama said in a statement.
"The economic agreements he helped forge have created millions of American jobs and added billions of dollars to our economy, and he's perfectly suited to build on that progress in his new role."
Baucus has been a critic of the implementation of Obama's health care law, branding it a potential "train wreck" earlier this year.
More From This Section
Baucus had already announced his intent to retire, but his departure a year before mid-term elections will allow Montana's Democratic governor to appoint a successor -- potentially boosting the new senator's stature and fundraising clout before November's polls.
In turn, that could enhance the chances of Obama's Democrats holding on to control of the Senate.
Baucus is also close to Jim Messina, the campaign manager who helped the president win re-election last year.
The appointment was first reported earlier this week by the Politico news organisation.
Before succeeding current US ambassador to China Gary Locke, Baucus will have to be confirmed by his colleagues in the Senate.
Baucus said in a statement that he was humbled by the nomination
"The US-China relationship is one of the world's most important bilateral relationships," he said.