Hughes, who has one year remaining on his current contract, has rejected the chance to pen fresh terms at Vicarage Road and he has not played for the club this season.
Watford are now facing up to the prospect of losing the 26-year-old, who is attracting strong interest from the Premier League pair.
The Eagles have already made a bid for Hughes, believed to be in the region of £5million, but that was rejected.
A fresh approach from them is expected in the coming days and an offer of closer to £10m could see Hughes head to Selhurst Park.
Burnley are also interested in the midfielder and are not out of the running to sign him just yet.
Aston Villa had expressed an interest in Hughes earlier this summer, but they have not made a concrete bid at any point.
Watford are, coincidentally, taking on Crystal Palace on Tuesday night as the two sides meet in the second round of the Carabao Cup at Vicarage Road.