The nucleolus has long been known as a functionally highly specialized subnuclear compartment where synthesis, posttranscriptional modification, and processing of cytoplasmic rRNAs take place. In this study, we demonstrate that the nucleolus contains all the trans-acting factors that are responsible for the accurate and efficient synthesis of the eight 2'-O-methylated nucleotides and three pseudouridine residues carried by the mammalian U6 spliceosomal small nuclear RNA. Factors mediating the formation of pseudouridine residues in the U3 small nucleolar RNA are also present and functionally active in the nucleolus. For selection of the correct target nucleotides in the U6 and U3 RNAs, the nucleolar 2'-O-methylation and pseudouridylation factors rely on short sequences located around the target nucleotide to be modified. This observation further underscores a recently proposed role for small nucleolar guide RNAs in the 2'-O-methylation of the U6 spliceosomal RNA (K. T. Tycowski, Z.-H. You, P. J. Graham, and J. A. Steitz, Mol. Cell 2:629-638, 1998). We demonstrate that a novel 2'-O-methylated nucleotide can be generated in the yeast U6 RNA by use of an artificial 2'-O-methylation small nucleolar guide RNA. We also show that a short fragment of the 5.8S rRNA, when expressed as part of the human U6 RNA, is faithfully 2'-O-methylated and pseudouridylated. These results are most consistent with a trafficking pathway in which the U6 spliceosomal RNA cycles through the nucleolus to undergo nucleolar RNA-directed modifications.