Some speculation:

Looking at the datasheet for the (or a similar) encoder, it looks to have a Y style setup of switches, ie a common tab and two branches. I think you need to provide voltage the common branch and then check for pulsing (and in which order) on the branches to determine activity and direction. If the empeg uses a dedicated little circuit for this it could have broken somehow. Or if the feed drops out, or one or both branches, solder joints, circuit board track, component...
Lot's of other things than the actual rotary encoder can be the culprit...

/Michael