A density functional theory for colloidal dynamics is presented which includes hydrodynamic interactions between the colloidal particles. The theory is applied to the dynamics of colloidal particles in an optical trap which switches periodically in time from a stable to unstable confining potential. In the absence of hydrodynamic interactions, the resulting density breathing mode, exhibits huge oscillations in the trap center which are almost completely damped by hydrodynamic interactions. The predicted dynamical density fields are in good agreement with Brownian dynamics computer simulations.