Stupid Baker's Hat

I'm sure most of you have something that you/your child wears when you sleep to protect your hair.
C prefers to wear a satin sleep cap, or as we call it, a bonnet. 
Ok, with that said I have a little story for you!...

My sister and her family were having a party to watch something on pay per view, so I took my kids to watch the event.  It wasn't going to get over until late and I knew that C would either want to lay down at my sister's house or she would fall asleep in the car on the way home, so we put her hair into a french braid (a "night-time" braid) and put her bonnet on before we left home. 
C hates to be seen in her bonnet because she's been told so much that it looks bad, but I assured her that it was only going to be family and no one would say anything to her about it.

So, a couple hours go by and no one seemed to notice C was in her bonnet until she came into the kitchen where I was talking to one of my sister's friends.
When my sister's friend saw C in her bonnet, she yelled out "WHY IS SHE WEARING THAT STUPID BAKERS HAT?"  I told her the reason as nicely as possible.  Then she says "She doesn't want to wear this stupid looking thing!" 
Now here's the part where I flew off the handle!
My sister's friend pulled the bonnet off her head and said "Her hair is beautiful! Don't you DARE put this stupid thing back on her!"  And tried to put it in her pocket. 
I'm not even going to tell you what I said to her!  Notice how the word 'tried' is underlined!

Anyway, after I got my anger out, she did apologize and for some reason felt the need to keep repeating that she wasn't racist...  I didn't even have a thought that what she did was out of racism.  I was mad because #1, she insulted my daughter for wearing something she needs right in front of her when she's already embarrassed by it, and then she took it off her head and tried to keep me from getting it back!  Plus I told C no one would say anything, so I had to stick up for her even more.  She had absolutely no right at all to tell me what to do with my own child and I made that perfectly clear.
One thing about me is I'm the sweetest person until you make me mad, and it takes a lot to get me as mad as I was that night!  When it comes to my kids, I'm obviously very protective and very defensive.  No one gets away with saying something bad about my kids or doing something bad to them.  My sister has acted like she hated me ever since that night, and now she talks to me even less than before.  The woman's husband and one of my sister's other friends agreed with me.

So what my question is, do you think I overreacted? What would you have done or said?