Palace midfielder Mile Jedinak fouled Deeney in the area and the Watford striker calmly converted the resulting penalty after 15 minutes.
Watford had chances to extend their lead but Emmanuel Adebayor headed in an equaliser on the stroke of halftime, the
Togo striker's first goal for his new club.
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Adebayor almost scored again with another strong header but it was well saved by Watford keeper Heurelho Gomes and Deeney sealed the points for the visitors with a firm drive eight minutes from time.
"It is a massive win. We target teams in and around us to take the points and it was a well deserved victory, and a well fought one," Deeney told the BBC.
"I thought we dominated the first half, but when they got a goal at the end of the half we knew a reaction was coming so it was about managing that," he added.
"We are just getting closer to the 40-point mark."
Palace have not won in nine Premier League games.
"We were not good in the first half. We were much improved in the second half and should have won it, so a bit of a blow to lose the game," Palace manager Alan Pardew said.
"We made a slight error on the Watford winner. I can't think of too much of a threat they had in the second half," he added.
"We are on a tricky run and need to fight our way out of this form."
(Reporting by Ed Osmond, editing by Pritha Sarkar)
