The opposition Socialists struck a deal with two smaller far-left parties over the weekend, all but guaranteeing Prime Minister Pedro Passos Coelho will fall.
Mr Passos Coelho's party emerged as the largest in October's election, but has no absolute majority.
Government bond yields hit a five-month high, while shares fell 1.9%.
"The scenario of a left-wing government and the ousting of the centre-right is about to become reality, which the markets obviously don't like," said Joao Lampreia, an analyst at Banco BiG.
Portugal's benchmark 10-year bond yields jumped over 20 basis points to 2.87%, the highest since July, as investors anticipated higher borrowing costs.
Socialist Party leader Antonio Costa sealed the so-called "Triple Left" pact with the Communist Party and Left Bloc over the weekend.
Together they will have 122 seats, enough to out-vote the centre-right coalition government, which was left with only 107 after October's inconclusive elections.
A vote on the government's programme is likely to take place on Tuesday, when the leftist parties are set to use their parliamentary advantage to topple the minority administration.
Matt Cairns, a strategist at Rabobank, said there were fears a change in government "could end up in some wind-back of austerity measures".
Another analyst, Rainer Guntermann at Commerzbank, warned "rating jitters are also on the rise for Portugal".
Amid the political uncertainty, Portugal's only investment grade credit rating will be assessed on Friday by credit agency DBRS.
The loss of that rating would bar Portugal from the European Central Bank's quantitative easing (QE) programme, Commerzbank warns.

Peel Energy and United Utilities want to add a further 16 turbines at Scout Moor, on land between Rochdale and Rossendale.
Rossendale Borough Council's development control committee gave the go-ahead for 14 of them at a meeting on Tuesday night.
Councillors in Rochdale are yet to rule on plans for the remaining two.
A statement from Rossendale Borough Council said their decision will now be referred to the government, which will then decide whether or not to "call-in" the decision for further debate.
Scout Moor wind farm opened in 2008 with 26 existing wind turbines generating enough electricity for 40,000 homes.
MW = Megawatts
Source: RenewableUK
However, opponents are concerned the expansion of the wind farm will impact negatively on the natural beauty of the area.
Proposals to double the size of the site have already been scaled down after a public consultation.
A joint planning application for expansion on Scout Moor and the neighbouring Rooley Moor was submitted to Rochdale and Rossendale Borough Councils.
The document states "if all the proposals... are consented they will result in the largest wind farm in England".
Jon England of Peel Energy said: "The UK is quite a highly populated country. Offshore is one of those areas which moves it away from communities but you are going to increase costs.
"If you increase the cost of construction of these sorts of developments you are going to increase the cost to the consumer.
"We've been out to the community many times. We've done tens of consultation events. Yes there is objection [to expansion].
"But in the scale of the population that see Scout Moor wind farm the level of objection is relatively low."
Portuguese bonds and stocks were hit on Monday as a coalition of left-of-centre anti-austerity parties looked set to form the country's next government.
[NEXT_CONCEPT]
Planning permission has been granted to create what is believed to be England's largest onshore wind farm.