Danny Graham's brace helped Watford extend their unbeaten run against Town to 13 games.
The Hornets' hitman stung Blues inside the first two minutes with a close range header and then doubled their advantage with a left foot strike on the hour to take his tally to 22 Championship goals for the season.
Don Cowie sealed the points for Watford with a 20 yarder as the game entered added on time.
Gareth McAuley headed against the post for Town and Connor Wickham spurned a couple of chances but Blues paid the price for defensive slip ups to make it four games without a win at home.
Town made two changes to the side that drew at Leeds at the weekend, Kieron Dyer dropping to the bench along with Darren O'Dea. Andy Drury and Mark Kennedy coming in.
Watford were in front though before the cheers over Dyer's return had died down, Graham left alone to head in from Don Cowie's cross following a short corner. Troy Deeney made sure the ball landed in the net but the goal went to the Championship's leading scorer.
Town responded with a Gareth McAuley header bringing a penalty appeal, Tamas Priskin then heading over. Connor Wickham sent a long range effort wide with Scott Loach off his line.
Referee Grant Hegley limped off after 10 minutes with what looked like a calf problem, fourth official David Rock taking his place.
Jimmy Bullard sent a terrific free-kick just over, before John Eustace was booked for a foul on the midfielder.
On 22 minutes Town were a coat of paint away from an equaliser, McAuley's header hitting the post and Wickham failing to get enough on the rebound to beat Loach.
Wickham's touch let him down from Drury's clever pass as Town threatened an equaliser but it was Watford who should have added to their score,
Graham escaping Grant Leadbitter down the left and his cross looked certain to be converted by Will Hoskins at the far post but he hit the sidenetting.
Eustace sent a long range strike over, Graham a header wide before Adam Thompson became the second Hornet to be booked for a foul on Martin.
Blues finished the six minutes of added on time with Priskin and Bullard both sending efforts wide in an entertaining first-half.
Thompson fired over from a tight angle as the second-half got underway, Watford making an early change with Buckley making way for Matt Whichelow, Town following suit with Dyer receiving a great ovation as he entered Portman Road in a Blues' shirt for the first time since 1999. Martin making way.
Great work by former Hornet Priskin, who robbed Martin Taylor, looked likely to set up Wickham until Adrian Mariappa's intervention before Watford doubled their lead on the hour. Bullard appeared to be fouled by Ross Jenkins but referee Rock didn't see it that way and Eustace set up Graham who cut inside Damien Delaney and buried a left foot shot into the corner.
Jason Scotland replaced Priskin before the restart, Deeney making way for Marvin Sordell in Watford's second change.
Former Town Academy 'keeper Loach held on after a superb Drury cross had fallen into his hands as Wickham challenged, the Town striker then fizzing a left wing cross in front of goal.
The England U21 international hooked the ball wide as Town looked for a way back into the game, Watford making a third change with Graham replaced by Aston Villa loanee Andreas Weimann for the last 10 minutes.
Watford wrapped up the scoring for Watford in added on time with Cowie converting confidently from the edge of the box to maintain their late push
for the Play-Offs and tarnish Dyer's return to his hometown club.
Town: Fulop, Edwards, McAuley, Delaney, Kennedy, Martin (Dyer 53), Leadbitter, Drury, Bullard, Wickham, Priskin (Scotland 62). Subs not used: Lee-Barrett, Peters, Smith, Civelli, O'Dea.
Watford: Loach, Thompson, Taylor, Mariappa, Doyley, Deeney (Sordell 66), Eustace, Jenkins, Cowie, Buckley (Whichelow 52), Graham (Weimann 81). Subs not used: Gilmartin, Bennett, Mingoia, Smith. Booked: Eustace, Thompson.