The World No.3 ranked Austrian overcame a stiff resistance from the 20-time Grand champion by beating the Spanish baseliner in two tight sets, both of which were decided by tie breakers.
Thiem showed a log of grit and resilience in the opening set as he saved two set points in the tie breaker and went onto take a 1-0 lead in the 3-set encounter. The US Open champion kept the level of his game intact in the second set too and edged Nadal in yet another tie breaker to seal the contest in two straight sets.
With two straight wins in his round robin encounters, Thiem is almost through to the semi-finals at the marquee year-end event for the second successive year.
Thiem will look to make it three wins in as many games when he takes on Andrey Rublev in his final round robin match on Thursday and look to earn his 300th tour-level win.
"The match was at a very high level with all strokes. I am very happy with the way I served, because most of the time when I get the first serve in, I am on the offence and I have a good percentage to win the point," said Thiem after the match.
"When I was in difficult situations like the first-set tie-break… the serve helped me a lot. I think it is maybe the most important stroke in indoor tennis. I am very happy that it worked well," he added.
Earlier on Tuesday, Russia's counterpunching baseliner Danii Medvedev defeated big serving German Alexander Zverev in straight sets.
Medvedev did not break much sweat as he won the encounter 6-3, 6-4 against his Zverev and kept his hopes alive for a semifinal berth along with World No.1 Novak Djokovic on top of the Group Tokyo 1970.
Zverev had once again issues with his services as he committed four double faults in opening two two service games, and found it difficult to get those booming services in all through the game. On the contrary, Medvedev returned well all through the game, winning 79 per cent of his second-serve return points (15/19) on way to his one-hour, 29-minute victory.