Reduce voltage going from absolute encoder to MCU
From reading your question and looking at the encoder data sheet it is clear that your encoder is equipped with what is called the "PNP output". That style of output will source current from the device positive supply for one logic state and shut that current off for the other logic state. To accommodate that type of encoder output you need to give your MCU an "NPN input" type circuit. There are a number of ways to do this with various types of circuits, components and chips. 

Possibly the simplest and most robust circuit to deal with this would be to use the following idea if you do not mind using low cost discrete components.



The diode D1 is placed in the circuit to protect the NPN transistor in the case that there are negative spikes on the wire from the encoder due to disturbance from other machine parts. 

This circuit will work well for most speeds that the encoder would operate at and you would only use single ended outputs from the encoder. If your encoder has a high line count and operates up toward its maximum RPM then you may find that the PNP/NPN type connections may not provide fast enough switching performance. It those cases you will want to use the differential output pairs for the A, B and 0 outputs of the encoder and get the part that has the 5V diff pair driver outputs. Then your MCU side would use a differential receiver for the signals such as shown in the encoder data sheet: