Forests have a key role in global ecosystems, hosting much of the world's terrestrial biodiversity and acting as a net sink for atmospheric carbon. These and other ecosystem services that are provided by forests may be sensitive to climate change as well as climate variability on shorter time scales (for example, annual to decadal). Previous studies have documented responses of forest ecosystems to climate change and climate variability, including drought-induced increases in tree mortality rates. However, relationships between forest biomass, tree species composition and climate variability have not been quantified across a large region using systematically sampled data. Here we use systematic forest inventories from the 1980s and 2000s across the eastern USA to show that forest biomass responds to decadal-scale changes in water deficit, and that this biomass response is amplified by concurrent changes in community-mean drought tolerance, a functionally important aspect of tree species composition. The amplification of the direct effects of water stress on biomass occurs because water stress tends to induce a shift in tree species composition towards species that are more tolerant to drought but are slower growing. These results demonstrate concurrent changes in forest species composition and biomass carbon storage across a large, systematically sampled region, and highlight the potential for climate-induced changes in forest ecosystems across the world, resulting from both direct effects of climate on forest biomass and indirect effects mediated by shifts in species composition.