Not recognizing her daughter (sister in-law) & me (Dementia & OCD). How do we handle this?

Is she in a facility? Has this behavior suddenly started to happen? Has she been checked for a UTI? UTIs are extremely common in elderly and can mimic or amplify dementia symptoms. Antibiotics clears it up and behaviors that aren't typical (unless she already has dementia).

Checking for UTI is a great suggestion. But it's the sudden extreme and perhaps violence that might indicate that so even finding and treating that may not completely eliminate this. If she has dementia of any sort not recognizing someone, especially someone from the last 1/3 of her life who can't be mistaken for say her husband or brother, don't take it personally. In general it has been my experience that trying to "correct" someone like this by insisting they accept or remember loved ones are dead or insisting their hallucinations aren't there only triggers that fight response you describe. They are different people, probably at different stages but when my mom hallucinates or mixes up generations we just go with it and gently let her either figure out shes confused or simply live in her altered reality. So far she comes around to knowing her mistake and here and now but the day no doubt is coming. Her hallucinations tend to come when she hasn't been getting enough water and they are strangers not deceased family members, at least as far as I know. When she tells me about them I often ask if she was frightened, she never has been and then say how nice you had company! When she has confabulated (I love this term another member here used recently) an elaborate story which has happened a couple of times, that is concerning to her we walk through it and I will question things that don't make any sense and she eventually will admit it probably didn't happen, though it's very vivid to her so I am always careful to say "I really don't think it happened" but not that it absolutely didn't. After all in her mind it did so... The few times she has been seeing someone with her I don't I have made sure she wasn't afraid of them and then encouraged her to talk to them or reach out and touch them to see if they are really there and she gently realizes she's hallucinating, then we just laugh. No harm not foul, just find the humor in it because there is nothing to be done (other than drink enough water in her case) and I don't want her to fear her hallucinations or loose trust in me letting her control them, if that makes any sense.

When your MIL doesn't know who you are and is fearful I would strongly recommend doing what you have to to remove that association of fear with you or any "stranger" for that matter at this point since she isn't apt to come in contact with any real strangers who shouldn't be there anymore. If she is too agitated to hear reason, leave and let her get used to you again. When she screams to your wife "who is this stranger" let your wife (whom she recognizes) go in and calm her down, "Mom I'm sorry I thought you would recognize Joe, he was helping me out. You know I would never let a total stranger come in alone without introducing you right?" "Mom this is my husband Joe, you remember our wedding?" or "Mom this is Joe, I forgot to warn you he just shaved his beard he does look so different but I kind of like it don't you?" Or you could always just remind her you are one of her caregivers that helps Sue out and then give her an excuse for not recognizing you right off the bat. Giving her a legit out, in my experience, causes far less digging in on their part because it gives them some control and allows them to save face, so to speak. If MIL eyes aren't good that's a great out, you aren't wearing your glasses or your new glasses make you see better so I'm not just a familiar out line anymore, hahahaha. My mom can laugh at herself, we are lucky so we always try to lighten these moments with laughter.

These episodes aren't a reflection on you at all, try to remember that, they are part of her disease process and there is constantly going to be adapting, a new normal going on, it's a marathon process most of the time rather than a sprint which can be both fortunate and unfortunate but there is no changing it, there is just changing the way we approach it.