The Portuguese, a former Ghana coach, took charge of the Walia Antelopes last year, signing a two year contract.
But a disappointing reign saw Ethiopia finish bottom of their 2015 Africa Cup of Nations qualifying group.
An official statement, sent to BBC Sport, says the EFF will pay an undisclosed amount of money to Baretto for ending the contract early.
Local media have reported on deep divisions between Barreto and the EFF's technical department.
Ethiopia are drawn with Algeria, Lesotho and Seychelles in their 2017 Nations Cup qualifying group.
They kick off their campaign against Lesotho in June.
The EFF have declined to suggest who may be in the frame to take charge of the national side for the qualifiers.