I have one LAST Idea as to the source of this problem:
As I understand their operation, a hall Effect switch outputs 1/2 of it's supply voltage in the on condition, so 5v in 2.5 v out, That's dangerously close to the logic low threshold of TTL, so any voltage drop in supply or signal and POOF no encodeer operation. Check the logic high voltage out of the Hall effect sensor and see what it is.
JS