The Jornada del Muerto Basin of southern New Mexico has undergone a marked transition of plant communities. Shrubs now dominate areas that were previously dominated by perennial grasses. The replacement of grasses by shrubs requires an establishment phase where small shrubs must compete with similar-sized grass plants. This is followed by a phase in which established shrubs sequester nutrients and water within their biomass and alter soil resources under their canopy, creating “islands” of fertility. We studied gas exchange and water relations of small and large shrubs growing in the Jornada del Muerto as a function of varying soil moistsure during the season. The small shrubs had greater net assimilation, stomatal conductance, transpiration, and xylem water potential than large shrubs following high summer rainfall in July and highest seasonal soil moisture. High rates of carbon assimilation and water use would be an advantage for small shrubs competing with grasses when shallow soil moisture was plentiful. Large shrubs had greater net assimilation and water-use efficiency and lower xylem water potential than small shrubs following a dry period in September when soil moisture was lowest. Low xylem water potentials and high water-use efficiency would allow large shrubs to continue acquiring and conserving water as soil moisture is depleted. Although the study provides evidence of differences in physiological responses of different-sized shrubs, there was not support for the hypothesis that small shrubs are more closely coupled to variation in soil moisture availability than large shrubs. Small shrubs may actually be less coupled to soil moisture than large shrubs and thus avoid conditions when continued transpiration could not be matched by equivalent water uptake.