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Users who are assigned to a group can select a watcher for their issue, but the only users available are Jira admins and themselves. They cannot select other users from this group.
The group is already added to "Manage Watchers" and "View Voters and Watchers" for the project and "Browse users and groups" in global permissions.
I'm not sure what else to change...
Note that the project is set that only admins and the issue's reporter can see their issues. Not sure if that's why the reporter can't select others. So ideally, a reporter can select a watcher from their group and they would also be able to see the issue.
Update: While I still can't get the watchers working correctly, I opted to use a custom multi-user field and added the appropriate permissions. All is working as expected.
The other option might be to use the permission helper for the selected user and the Manage Watchers permission to see what it says.