Goncalo Guedes scored the opener at Mestalla on Wednesday, with Valencia moving within a point of the Champions League places after extending their unbeaten run to 17 games in all competitions.
Madrid, having needed a late Karim Benzema goal to beat bottom side Huesca last time out, underwhelmed again despite the return of star names including Ballon d'Or winner Luka Modric.
Ezequiel Garay superbly converted a corner from Daniel Parejo to double the lead, though Valencia missed out on a sixth straight clean sheet at home in the league due to Benzema's 93rd-minute header.
Sergio Ramos saw an early penalty appeal rejected by referee Santiago Jaime Latre after he was challenged in the air by Garay.
Neto easily claimed a speculative long-ranger from Toni Kroos but Valencia took the lead in the 35th minute after Keylor Navas flapped at a corner.
Guedes and Carlos Soler played a clever one-two and the former beat Navas at his near post with a smart strike.
Soler should have set up Guedes again at the end of a rapid counter-attack started by Neto in the 53rd minute, but instead saw his shot blocked by Navas, while Rodrigo Moreno fired wide.
Zidane introduced Isco and Gareth Bale in a double change but Madrid continued to toil; Marcelo blazed a hopeful volley well over the crossbar and the Brazil left-back was later booked for a blatant dive.
Valencia finally scored the second goal their excellent performance deserved with seven minutes remaining, Garay beating Casemiro in the air to nod home Parejo's terrific corner.
Madrid were denied a late penalty when Ramos was fouled by Mouctar Diakhaby, the centre-back flagged offside after the referee had initially pointed to the spot, although Benzema did get a goal back with just seconds remaining.
Madrid in danger of drifting
With eight games to go, Madrid are a massive 13 points behind leaders Barcelona but 10 points clear of Getafe in fourth, leaving them little to play for. Zidane faces a challenge to keep his side motivated in games that have nothing riding on them.
Valencia, meanwhile, continue their charge and are now surely favourites for the last qualification place for the Champions League,their poor start to the season long forgotten. They are increasingly irresistible at Mestalla.
