Mfuni, 17, signs until the end of the season from the Premier League giants, following in the footsteps of Max Alleyne, and was registered in time to be available for tomorrow's Championship clash against Swansea City.
Pep Guardiola has been full of praise for the way Watford handled Alleyne before his recall at the start of January and the relationship between the two clubs meant the Hornets were earmarked as an ideal destination for Mfuni, who is left-footed and considered an option at centre-back or left-back.
Mfuni has been capped 17 times at England Under-19 level and made his first-team debut for City in their 10-1 hammering of Exeter City in the FA Cup earlier this month.
The defender has often featured on City's bench recently, too, including in this month's Manchester derby and as recently as for their Champions League win over Galatasaray on Wednesday night.
He has experience of winning at Vicarage Road, having been part of the City side that beat Watford in the FA Youth Cup semi-final in WD18 last season.
Stephen Mfuni is a highly-rated centre-backStephen Mfuni is a highly-rated centre-back (Image: Watford FC)
Assistant to the sporting director Valon Behrami said: "Stephen is a player City rate highly.
"They consider carefully where they send their top talent and they were happy to send him to us because of the way we helped develop Max Alleyne.
"Stephen is only 17 but he is an intelligent player who defends the space in behind.
"He carries the ball well out of defence, is quick and can play centre-back and left-back. We are excited to have him with us."
Mfuni takes the number 21 shirt at Vicarage Road and provides Javi Gracia with an extra option in an area of the pitch where injuries are hitting hard.
He joins Edoardo Bove as Watford's second recruit of the window, with Udinese defender Saba Goglichidze likely to follow before Monday's deadline.