Abstract Grasslands face more frequent and extreme droughts; yet, their responses to increasing drought intensity are poorly understood. Increasing drought intensity likely triggers abrupt shifts (thresholds) in grassland ecosystem functioning which can implicate recovery trajectories. Here, we determined how drought intensity affects plant productivity, and plant–soil carbon (C) and nitrogen (N) cycling. We exposed model grassland plant communities with contrasting resource acquisition strategies (a fast‐ vs a slow‐strategy plant community), to a gradient of drought intensity. The drought gradient ranged from well‐watered to severely water‐limited conditions. We identified thresholds of plant community productivity (above‐ground biomass) at peak drought and 2 months after re‐wetting, and measured net ecosystem exchange and ecosystem respiration of C throughout the drought and recovery phases. At peak drought and 1 week after re‐wetting, we traced recently acquired C from plants to the soil and into microbial biomass and fatty acids using ¹³C pulse labelling, and measured plant and soil N. At peak drought, slow‐strategy plant communities were more drought resistant than fast‐strategy communities, as the threshold in plant productivity occurred at a higher drought intensity for the slow‐ than the fast‐strategy community. Shortly after re‐wetting, microbial uptake of recent plant‐assimilated C increased with increasing past drought intensity, coinciding with an increase in soil N availability and leaf N. Threshold responses to drought intensity at peak drought translated into non‐linear recovery responses, with greater compensatory growth in the fast‐strategy community. At peak drought, increasing drought intensity reduced C uptake and increased relative C partitioning to leaves and microbial biomass. Upon re‐wetting, plant community strategy mediated drought intensity effects on plant and soil C and N dynamics and plant recovery trajectories. The fast‐strategy community recovered quickly, with higher leaf N than the slow community, while the slow community increased C allocation to microbial biomass. Synthesis. Our findings highlight that C and N dynamics in the plant–soil system display non‐linear responses to increasing drought intensity both during and after drought, which has implications for plant community recovery trajectories.