Dear Nic:
I am dumbfounded by your post. You articulated your scenario so well that I felt every emotion you felt as you were describing it.
Unfortunately I lack the ability to eloquently say on paper the right words to comfort you - except that to expect "should I be laughing at this" is absolutely out of the question. What you experienced must have been excruciating.
I have experienced this discomfort with my N sister, but on a lesser scale; because she now lives in another state and my contact with her is few and far between - and usually buffered by my N mother. However, it is still painful as I never know exactly what to say or do when I am around her. I'm obligated to be around her only one holiday a year and yet I shake, shiver and get queasy just approaching my mother's house when she is there. We have been estranged for about 5 years, and yet I am faced with the obligation of small talk. I thought it would get easier as time went on - but in fact, I think its more difficult. I break out in hives on my chest, and feel like I am going to explode with discomfort.
take comfort that your wife is sympathetic to this. My husband says things like "just relax, why do you allow her to make you feel this way" - when he says things like this I visualize asking a two year old to remove the chocolate from their mouth that they already started chewing. Like that's going to work!!
I wish I knew what to say Nic, except that someday, we will be able to find some level of peace with this. I haven't found it yet, but you can bet if I do, its going to be shared with everyone on this board. It must really be hard living next door to them.
So sorry you had to deal with that. Hugs.