7i76E one PWM needed

I see.. spindle-at-speed is TRUE so that should be okay.

motion.spindle-index-enable will not be set true until spindle synchronized motion
( G33, G33.1 G76 etc ) is required. so I would not expect any index activity until then

If you simply want to check the hardware part of index operation, you can:

sets spindle-index-enable true
(either via axis or via halcmd)

and watch spindle-index-enable as you rotate the spindle by hand
it should get set false at the index location

That's also working!. I've tried this code:

G90 (absolute distance mode)
G0 X1 Z0.1 (rapid to position)
S100 M3 (start spindle turning)
G33 Z-2 K0.125 (move Z axis to -2 at a rate to equal 0.125 per revolution)
G0 X1.25 (rapid move tool away from work)
Z0.1 (rapid move to starting Z position)
M2 (end program)

When the G33 is executed I see the spindle-index-enable is set to true. At the index it will go to false which is correct?
But after that it does not go back to true anymore. There is no motion. So some other signal is not correct. I've noticed the
spindle-revs is negative. Not sure if it matters.

Yep, AFAIK spindle-revs has to be correct or you will be stuck waiting forever

But why are the numbers negative? I did not hook up input-b of the encoder. My encoder just has one phase and the index signal.
The counts are also negative. So I have to make input-b true to make sure the encoder counts positive.

Either set the B input to TTL mode and (I think) tie it low or reverse the encoder scale