I understand how this can be disappointing, but they were going to end up hurting someone’s feelings either way. By excluding everyone in that category it’s less personal. I can’t imagine having the entire family know only some aunts/uncles were invited and being among those who were excluded. That’s deeply personal and I’d be very hurt.
My kiddos have aunts and uncles they saw frequently pre-Covid just because of how close they live. There are others who love them just as much but live farther away. Should the aunt who’s a single mom be cut out because she couldn’t afford to travel across the country to see us every year (or vice versa)? If it were my kids I’d encourage them to invite all or none. I think your niece is doing the right thing, but your sister could have handled it better. She should have picked up the phone and had a conversation with you. And whoever repeated the story to your niece needs to rethink how much they share. No good was going to come from that.