I think that knitting is something that people do seem to take very much to heart. There are many other things you can do for someone that involves just as much 'love and effort' as knitting jumpers.
I admit, it's not something I understand as I don't knit myself, but it just seems to be so emotive for people. More so than many other much more important things.
In a nutshell OP, what I'm trying to say is that no, of course yours not being unreasonable to be upset, we can't controlling whether something upsets us or not. You were obviously looking forward to knitting for your grandchild as it's a hobby you enjoy, and that is completely understandable.
But all the time, effort and love in the world simply cannot change the fact that someone either likes knitted clothes or they don't. It's not a personal insult to the knitter, it's just different taste.
I can only speak from my own pov obviously but I'd be gutted if someone used something they really didn't like simply because they appreciated the effort I made. I'd much rather they just told me not to make the effort in the first place. That way I could do something that they really did like.
I know you're feelings are hurt, and I can see that you see it a rejection, but once this has all died down I do think think that you will genuinely see that it's nothing more than your daughter having different taste to you.
I'll bet you didn't have the same taste as your parents 